New Enterprise Associates 14, L.P. v. Rich

EFiled: Mar 09 2023 08:00AM EST
Transaction ID 69300274
Case No. 2022-0406-JTL
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
NEW ENTERPRISE ASSOCIATES 14, )
L.P., NEA VENTURES 2014, L.P., )
NEA:SEED II, LLC, and CORE )
CAPITAL PARTNERS III, L.P., )
)
Plaintiffs, )
)
v. ) C.A. No. 2022-0406-JTL
)
GEORGE S. RICH, SR., DAVID )
RUTCHIK, JOSH STELLA, FUGUE, )
INC., GRI VENTURES, LLC, JMI )
FUGUE, LLC, RICH FAMILY )
VENTURES, LLC, and RUTCHIK )
DESCENDANTS’ TRUST, )
)
Defendants. )
OPINION ADDRESSING MOTION TO DISMISS UNDER RULE 12(b)(6)
Date Submitted: January 24, 2023
Date Decided: March 9, 2023
C. Barr Flinn, Paul J. Loughman, Michael A. Carbonara, Jr., YOUNG CONAWAY
STARGATT & TAYLOR, LLP, Wilmington, Delaware; Michele D. Johnson, LATHAM
& WATKINS LLP, Orange County, California; Eric Leon, Nathan Taylor, Meredith
Cusick, Amanda R. Kurzydlowski, LATHAM & WATKINS LLP, New York, New
York; Counsel for Plaintiffs.
John P. DiTomo, Sebastian Van Oudenallen, MORRIS, NICHOLS, ARSHT &
TUNNELL LLP, Wilmington Delaware; Patrick Montgomery, Paul Weeks, KING &
SPALDING LLP, Washington, DC; Counsel for Defendants.
LASTER, V.C.
Fugue, Inc. (the “Company”) is a startup that spent six months looking for a buyer.
No one was interested. After declaring the sale process a failure, the Company needed
capital.
Management represented that a financing round led by an investor named George
Rich was the only available option. In return for the financing, the Company agreed to
issue shares of preferred stock that carried powerful blocking rights. Rich brought David
Rutchik and other investors into the round, and all received shares of preferred stock.
Three months after the recapitalization, the Company had $8 million on its books,
was no longer in distress, and had received a preliminary inbound expression of interest
from a potential acquirer. Rich, Rutchik, and the Company’s CEO comprised the board of
directors (the “Board”). The Board approved a transaction in which selected preferred
stockholders, including Rich and Rutchik, purchased additional shares at the original
issue price, set when the Company was in distress. The directors also granted themselves
millions of options, with the strike price set at one tenth of the value of the common stock
implied by the recapitalization.
The preliminary expression of interest blossomed into an acquisition at a healthy
valuation. When the transaction closed, the preferred stockholders received a return of
nearly 750%. The option holders received a return of 3,200%. Those gains came at the
expense of other Company stockholders, who suffered dilution from those equity
issuances and therefore received a lesser share of the merger consideration.
The plaintiffs are two investors who had funded the Company before the
recapitalization. One of the plaintiffs had a right of first offer (“ROFO”) that applied to
any issuance of securities. The Company did not honor the ROFO for the second offering
of preferred stock. That plaintiff has stated a claim for breach of contract, as well as a
claim for tortious interference with contract.
The plaintiffs have attempted to assert claims for breach of the duty of disclosure.
They argue that when asking a subset of the preferred stockholders to execute a written
consent approving the second offering of preferred stock, the directors had an obligation
to disclose that the Company had received a preliminary expression of interest from a
potential acquirer. That claim would fail in the context of a publicly traded entity. Under
the facts and circumstances present in this case, it is reasonably conceivable that the
information was material given that (i) the Company had told its investors three months
earlier that its process of exploring alternatives had failed, (ii) management had
simultaneously told its investors that it would take two to three years before the Company
had built up its business to a point where it could be sold, and (iii) the directors were
seeking approval to sell shares of preferred stock to selected investors, including two
insiders, at the same distressed price set in the recapitalization.
The additional twist is that the plaintiffs do not allege that the directors had a duty
to disclose the existence of the expression of interest to them. They allege that the
directors breached a duty to disclose the expression of interest to other stockholders,
resulting in injury to the plaintiffs when those stockholders were misled into approving
the second offering at the same price paid in the recapitalization. Although this decision
holds that the plaintiffs can assert that cause of action, the resulting claim is derivative,
2
and the plaintiffs’ standing to assert it was extinguished when the Company was sold.
The same is true for the plaintiffs’ related claims against other defendants.
The plaintiffs have sued the directors for breaching their fiduciary duties in
connection with the sale of the Company. The plaintiffs contend that the second offering
of preferred stock and the option grants were interested transactions, and they challenge
the sale of the Company as unfair because it conferred a unique benefit on the directors
by extinguishing any sell-side stockholder’s standing to pursue derivative claims
challenging those issuances, even though the merger consideration failed to afford any
value to those derivative claims. The plaintiffs have standing to challenge the merger on
that basis, and they have stated viable claims for breach of fiduciary against the directors
and against Rich’s affiliates as controlling stockholders, as well as a viable claim against
Rutchik’s affiliate for aiding and abetting breaches of fiduciary duty.
The defendants have an additional argument for dismissal that this decision does
not reach. As part of the recapitalization, the plaintiffs entered into a voting agreement
that contained a drag-along right. The plaintiffs covenanted not to sue the defendants over
any transaction that met the conditions of the drag-along right. The court will address the
implications of the covenant not to sue in a separate decision.
3
I. FACTUAL BACKGROUND
The facts are drawn from the operative complaint and the documents that it
incorporates by reference.1 At this procedural stage, the plaintiffs are entitled to have the
court credit their allegations and draw all reasonable inferences in their favor.
A. The Company
Founded in 2012, the Company provides tools to build, deploy, and maintain a
cloud infrastructure security platform. Josh Stella was a co-founder of the Company and
serves as its Chief Executive Officer.
In 2013, plaintiff Core Capital Partners III, L.P. (“Core Capital”) was the lead
investor in the Company’s seed round. Core Capital is an investment fund sponsored by
Core Capital Partners, which describes itself as a venture capital firm headquartered in
downtown Washington, D.C., with in excess of $300 million under management across
three funds.2
In 2014, plaintiffs New Enterprise Associates 14, L.P., NEA Ventures 2014, L.P.,
and NEA:Seed II, LLC invested in the Company. Each is an investment vehicle or fund
sponsored by New Enterprise Associates, a name-brand venture capital firm. The
Citations in the form “Ex. __” refer to documents attached to the Affidavit of
1
Sebastian Van Oudenallen, which collects documents incorporated by reference in the
operative complaint. Dkt. 14.
2
Core Capital Partners, http://www.core-capital.com/about (last visited Feb. 16,
2023).
4
distinctions among the entities are not important for this decision, which for simplicity
refers to them as “NEA.”
Across multiple rounds of financings, NEA invested a total of $36.1 million in the
Company, and Core Capital invested a total of $1.7 million. In return for their
investments, NEA and Core Capital received shares of preferred stock. The rights
conferred by their preferred stock included an aggregate liquidation preference equal to
their invested capital, and NEA and Core Capital each received the right to appoint one
member to the Board. During this period, the Board had five members.
B. The Failed Sale Process And The Recapitalization
In the second half of 2020, the Company began exploring strategic alternatives.
The principal goal was to find a potential acquirer. The process continued throughout
2020 and into the first quarter of 2021. During that time, the Company engaged with
more than fifteen possible buyers.
Toward the end of the first quarter of 2021, Stella told the Board that the
Company’s efforts to find a buyer had failed. Stella also represented that that Company
was running out of money and needed additional capital to continue operating. He
indicated that the Company would use the new money to grow its business and position
itself better as an acquisition target. According to Stella, that process would take two to
three years.
To provide the growth capital that the Company needed, Stella recommended that
the Company engage in a recapitalization that would involve the issuance of Series A-1
Preferred Stock to a group of investors led by Rich (the “Recapitalization”). Stella
5
represented to the Board and the Company’s existing investors that the Recapitalization
was the only option available and that a market check for other financing sources had not
generated any alternatives.
Based on Stella’s representations, the Board authorized management to proceed
with the Recapitalization.
C. The Terms Of The Recapitalization
The Company raised roughly $8 million in the Recapitalization. In return for this
capital, it issued 13,129,810 shares of Series A-1 Preferred Stock (the “Preferred Stock”),
reflecting a purchase price of $0.61 per share. The Recapitalization valued the
Company’s pre-transaction equity at $10 million.
Rich invested in the Recapitalization through two vehicles: GRI Ventures, LLC,
and JMI Fugue, LLC (together, the “Rich Entities”). Both of the Rich Entities were
special purpose vehicles that Rich formed for the investment. Rich controlled those
vehicles through Rich Family Ventures, LLC. GRI Ventures was designated as the “Lead
Investor” for the round. It invested $4,189,999.51 in return for 6,876,743 shares of
Preferred Stock. JMI Fugue invested $999,999.62 in return for 1,641,227 shares of
Preferred Stock. Together, the Rich Entities held 8,511,970 of the shares of Preferred
Stock, representing 65% of the issuance.
Twenty-three other investors participated in the Recapitalization. Eleven already
owned common stock in the Company. Another five were Company employees. Only
seven appear to be new investors.
NEA and Core Capital were invited to participate. They declined.
6
For the Company’s existing investors, the terms of the Recapitalization were
onerous. In the Recapitalization, all of the existing preferred stock was converted into
common stock. Before the Recapitalization, the preferred stock held by the Company’s
investors carried an aggregate liquidation preference of $74.6 million, with $37.7 million
associated with shares of preferred stock held by NEA and Core Capital. The conversion
into common stock wiped out the liquidation preference.
After the Recapitalization, only the new Preferred Stock carried a liquidation
preference. Not only that, but it was a supercharged liquidation preference equal to two
times invested capital. The Preferred Stock was also participating preferred, meaning that
if there was a liquidity event, the holders of Preferred Stock would (i) receive a payment
equal to two times their invested capital before any amounts reached the common
stockholders and (ii) have the right to participate pro rata with the common stockholders
in any further distributions.
The effect of the Recapitalization on the existing investors was dramatic. NEA’s
economic ownership in the Company declined from 32% of the equity value before the
Recapitalization to 14% afterward. Core Capital’s economic ownership in the Company
declined from just under 3% before the Recapitalization to less than 1% afterward.
From a governance standpoint, the effect of the Recapitalization was even more
significant. The Company’s post-transaction capital structure consisted of 8,921,712
shares of common stock and 13,129,810 shares of Preferred Stock. The Preferred Stock
voted on an as-converted basis, giving it 60% of the Company’s voting power. The
Preferred Stock also carried class voting rights, and the approval of the Preferred Stock
7
voting as a separate class was required for significant corporate actions, including
engaging in a merger, a sale of assets, or any issuance of shares; increasing the number of
directors; amending the certificate of incorporation or the bylaws; and dissolving the
Company. Because the Rich Entities acquired 65% of the issuance, they controlled the
voting rights that the Preferred Stock carried. On a fully diluted basis, the Rich Entities
owned shares carrying 39% of the Company’s voting power.
As part of the Recapitalization, the Company and certain of its stockholders
entered into a Fourth Amended and Restated Voting Agreement dated as of April 30,
2021 (the “Voting Agreement”). All of the purchasers of Preferred Stock executed the
Voting Agreement, as did twenty-nine holders of common stock, including NEA and
Core Capital (the “Signatory Stockholders”).
Under the Voting Agreement, the Signatory Stockholders agreed to vote for (i)
one director designated by GRI Ventures, who initially was Rich, (ii) a second director
designated by the holders of a majority of the Preferred Stock, who initially was Rutchik,
(iii) a third director elected by a majority of the Preferred Stock held by investors other
than GRI Ventures, who initially was John Morris, (iv) a fourth director who would be
the CEO, and (v) a fifth director designated by all the outstanding stock voting together
as a single class, who initially was Wayne Jackson. Because the Rich Entities held
approximately 65% of the Preferred Stock, they had the contractual authority to designate
the first two of the five directors. Because the Rich Entities controlled 39% of the
Company’s fully diluted voting power, they had an outsized voice in the selection of the
fifth director.
8
Morris and Jackson had been directors of the Company before the
Recapitalization. Rutchik was one of the twenty-three individuals and entities who
participated in the Recapitalization. Through the Rutchik Descendants’ Trust (the
“Rutchik Trust”), Rutchik paid $324,999.41 to acquire 533,398 shares of Preferred Stock.
Rutchik also was affiliated with Nodozac LLC, which paid $99,999.54 to acquire
164,122 shares of Preferred Stock. Through his affiliates, Rutchik acquired a total of
697,520 shares, representing 5% of the issuance.
Section 3.2 of the Voting Agreement contained a drag-along provision that
obligated the Signatory Stockholders to support a sale of the Company if approved by the
Board and a majority of the Preferred Stock (the “Drag-Along Provision”). As part of the
Drag-Along Provision, the Signatory Stockholders agreed not to exercise appraisal rights
and covenanted not to sue the directors or their affiliates in connection with a sale of the
Company that met the requirements of the Drag-Along Provision (the “Covenant Not To
Sue”).
NEA negotiated a side letter as part of the Recapitalization (the “Management
Rights Letter”). It granted NEA a ROFO if the Company proposed to offer or sell any
“New Securities,” defined broadly in a related document to mean any additional equity or
securities convertible into equity (the “Investor ROFO”). The Investor ROFO required
that the Company give notice to NEA of its intent to offer any equity securities for sale,
9
the number of equity securities to be offered, and the price and terms of the offer, so that
NEA could participate in the offering if it chose to do so.3
The Recapitalization became effective on April 30, 2021. Shortly before the
effective time, Stella and Rich proposed to increase the size of the Recapitalization from
$8 million to $10 million. The Board, which still included representatives of NEA and
Core Capital, rejected that proposal. It is reasonable to infer that the existing investors did
not want to suffer the additional dilution from a larger investment and believed that the
slightly smaller investment would fund the Company to a liquidity event. At a minimum,
having $8 million on its books would put the Company in a stronger position to negotiate
if it sought additional capital.
D. An Expression Of Interest
In late June 2021, something unexpected happened. Guy Podjarny, the founder
and CEO of Snyk Limited, contacted Stella about a potential strategic transaction. Snyk
is an England-registered corporation with its headquarters in Boston, Massachusetts.
Snyk provides a developer security platform.
On June 30, 2021, Podjarny emailed Stella to follow up on a prior conversation
they had the week before, writing: “I’d love to engage in a proper chat about a potential
deep partnership or (maybe more likely) acquisition.” Ex. 5. He advised that Snyk could
“dig in reasonably quickly” to determine the terms of a deal, and he suggested signing “a
3
Core Capital also entered into a side letter with the Company, but it primarily
addressed information rights and did not include a ROFO.
10
fresh MNDA and a refresh mutual demo.” Id. He also referenced a desire to “catch you
up on what we’ve been up to since our last conversations,” suggesting there had been
more than one prior conversation with Stella. Id.
The Snyk inquiry was significant. From mid-2020 until the end of the first quarter
2021, the Company had made outbound calls about a potential sale and spoken with
fifteen possible buyers. Those efforts had not generated any interest. Now, the Company
had received an inbound inquiry from a credible transaction partner who was already
known to the Company. The contact was preliminary, but it demonstrated that someone
had real interest in the Company. That put a different cast on the Company’s situation.
The Board did not disclose Snyk’s expression of interest to any of the
stockholders. The Board did not share the information with NEA under the Management
Rights Letter.
E. The Second Offering
On July 14, 2021, Morris and Jackson resigned from the Board, leaving Rich,
Rutchik, and Stella as the only three directors. One week later, on July 21, the Board
authorized the Company to issue a total of 3,938,941 additional shares of Preferred Stock,
which increased the outstanding shares of Preferred Stock by 18% (the “Second
Offering”).
Rather than treating the Second Offering as a new transaction, the Board decided
to amend the terms of the stock purchase agreement governing the Recapitalization to
encompass the Second Offering. By doing so, the Board permitted the shares to be issued
at the same price and with the same generous terms that Rich and his co-investors had
11
extracted in April 2021 when the Company was low on cash, had no other sources of
financing, and had no prospect of a near-term sale. Three months later, the Company had
$8 million on its books and had received an inbound expression of interest.
To effectuate the Second Offering, the Board unanimously approved an
amendment to the Company’s certificate of incorporation (the “Charter Amendment”)
that increased the authorized number of shares of Preferred Stock from 13,129,810 to
17,068,751. Under Section 242 of the Delaware General Corporation Law (the “DGCL”)
and the charter, the amendment required three stockholder-level votes: (i) an affirmative
vote from holders of a majority of the voting power of the Preferred Shares and the
common shares voting together as a single class, (ii) an affirmative vote from holders of a
majority of the voting power of the Preferred Shares voting as a single class, and (iii) an
affirmative vote from holders of a majority of the voting power of the Preferred Shares
excluding the shares held by the Rich Entities, voting as a separate class.
With 65% of the Preferred Stock, the Rich Entities could deliver the second vote
by themselves. With 42% of the outstanding voting power between them, Rich and
Rutchik only needed support from another 8% to carry the first vote.4 The third vote was
a tougher nut to crack. Net of the Rich Entities’ shares, there were 4,617,840 shares of
Preferred Stock outstanding. With Rutchik’s 697,520 votes in the plus column, they still
4
Before the Second Offering, Rich controlled 8,511,970 shares of Preferred Stock
and Rutchik controlled 697,520 shares of Preferred Stock. At the time, there were
8,921,712 shares of common stock outstanding and 13,129,810 shares of Preferred Stock
outstanding. (8,511,970 + 697,520) / (8,921,712 + 13,129,810) = 42%.
12
needed votes from holders of 3,920,320 shares of Preferred Stock. Conveniently, getting
the support from holders of that number of shares of Preferred Stock would carry them
well clear of the number of votes needed for the first vote. With those additional votes
added to the votes that Rich and Rutchik controlled, they would have 60% of the
outstanding voting power for purposes of the first vote.5
To obtain the necessary votes, the directors prepared a written consent with
signature blocks for twenty-one different holders of Preferred Stock, four of which were
entities associated with Rich or Rutchik. Ex. 3 (the “Written Consent”). Ten other holders
of Preferred Stock (the “Other Signatories”) joined Rich and Rutchik’s entities in
executing the Written Consent.6 The signature lines for seven additional holders remain
blank, supporting an inference that they declined to sign the Written Consent (the “Non-
Signatories”).7
5
The Rich Entities’ 8,511,970 votes plus Rutchik’s 697,520 votes plus 3,920,320
votes from additional shares of Preferred Stock = 13,129,810 votes / 22,051,522
outstanding votes = 59.54%.
6
As a reminder, the two entities associated with Rich are GRI Ventures and JMI
Fugue, LLC. The two entities associated with Rutchik are the Rutchik Trust and
Nodozac. The other ten holders whose signatures appear on the Written Consent are (1)
Peter Jaffee, (2) David Mitchell, (3) Tim Webb, (4) Chris Suen, (5) Ariel Eckstein, (6)
Cal Simmons, (7) Gustavo Bessalei and Amada Ali as joint owners, (8) the Jerry Simon
Revocable Trust dated June 8, 2016, (9) the Seth Spaulding Trust, and (10) the Legacy
Trust LLC. Id.
7
The seven non-signers are (1) Ajaipal S. Virdy, (2) Andrew Seligson, (3) David
Morris, (4) Ted Niedermeyer, (5) Ankush Khurana (6) Tyler Mills, and (7) Neil Glick
and William Boone Campbell as joint owners. Id.
13
Four of the Other Signatories received the right to purchase shares of Preferred
Stock in the Second Offering at the same favorable price Rich had secured in April 2021
when the Company needed capital and seemed to have no other options.8 That made them
interested in the transaction they were approving. Another (Chris Suen) was a Company
employee and, as such, was not disinterested in the transaction that he approved. Ex. 3.
Only five of the Other Signatories appear to not to have participated in the Second
Offering or to have ties to the Board.9
The buyers in the Second Offering were the Rich Entities, the Rutchik Trust, and
six other entities and individuals.10 All but one of the purchasers had voted in favor of the
Second Offering or had a relationship with someone who did. The buyers in the latter
category included George Rich, Jr., who is inferably Rich’s son. Only an entity called
Caplin Fugue LLC does not appear at this stage of the proceeding to have a discernable
relationship to a signer of the Written Consent.
8
Those four are (1) Gus Bessalel, (2) Peter Jaffee, (3) David Mitchell, and (4)
Neal Simon, who at the pleading-stage can be inferred to have an affiliation with the
Jerry Simon Revocable Trust. Ex. 2. Bessalel and Mitchell were also employees. See Ex.
3.
9
Those five are (1) Tim Webb, (2) Ariel Eckstein, (3) Cal Simmons, (4) the Seth
Spaulding Trust, and (5) the Legacy Trust LLC. Ex. 2.
10
The complaint alleges that Rutchik purchased his shares through the Rutchik
Trust. Compl. ¶ 58. The list of purchasers names Rutchik, rather than the Rutchik Trust.
Ex. 2. At the pleading stage, the court takes the complaint’s allegation as true. There is
not necessarily a conflict between the complaint and the list of purchasers because
Rutchik could have opted to purchase the shares through the Rutchik Trust.
14
The Rich Entities acquired another 2,790,086 shares of Preferred Stock,
representing 70% of the Second Offering. That purchase brought their total ownership to
11,302,056 shares of Preferred Stock, or 66% of the class. George Rich, Jr. acquired
164,122 shares of Preferred Stock, representing 5% of the Second Offering and another
1% of the class. After the Second Offering, Rich and his son controlled 44% of the
Company’s outstanding voting power.11
Rutchik acquired another 328,245 shares, representing 8% of the Second Offering.
Through the Rutchik Trust, he already owned 533,398 shares of Preferred Stock, and
through Nodozac, he owned another 164,122 shares, giving him a total of 1,025,765
shares, or 6% of the class. After the Second Offering, the shares Rutchik controlled
carried 3.9% of the Company’s outstanding voting power. If Rich and Rutchik acted
together, they controlled 48% of the Company’s outstanding voting power.12
The Second Offering raised another $2,402,754.01 for the Company. When added
to the $8 million raised in the Recapitalization, the Company had raised a total of $10.4
million, before transaction costs.
The plaintiffs allege that there was no valid business justification for the Second
Offering. Company management had represented to the Board that the $8 million
11
8,921,712 shares of common stock plus 17,068,751 shares of Preferred Stock =
25,990,463 total votes. The Riches owned shares of Preferred Stock carrying 11,466,178
votes. 11,466,178 / 25,990,463 = 44%.
12
Rutchik’s 1,025,765 votes plus the Riches’ 11,466,178 votes = 12,491,943 votes
/ 25,990,463 total votes = 48%
15
provided by the original Recapitalization supplied enough growth capital to meet the
Company’s needs. The Company certainly did not need to acquire additional capital on
the same terms as the Recapitalization. In July 2021, the Company was not in the same
situation as in April, when it needed cash desperately and lacked negotiating leverage.
The Company did not comply with the Investor ROFO when conducting the
Second Offering. The Company did not inform NEA of its intent to engage in the Second
Offering, nor did it allow NEA to participate.
F. The Option Grants
On July 29, 2021, the Board granted stock options to acquire 6,029,555 shares of
common stock at an exercise price of $0.10 per share (the “Option Grants”). Of that total,
2,945,352 options were issued to thirty-one different employees and two advisors (the
“Disinterested Grants”). The remaining 3,084,203 options, representing 51% of the total,
went to the members of the Board (the “Interested Grants”).
Stella received the vast majority of the Interested Grants, presumably because he
was the CEO. His grant of 2,050,227 options represented two thirds of the Interested
Grants and one third of the Option Grants as a whole. One fourth of Stella’s options
vested upon grant with the remainder vesting proportionately over a four-year period. All
of the unvested options would accelerate and vest if there was both a change of control
and Stella was terminated without cause within twelve months after the change in control.
Stella’s options thus had a double trigger for acceleration.
Rutchik received 886,265 options, representing 29% of the Interested Grants and
15% of the Option Grants as a whole. He received the largest grant of options after Stella.
16
The second-largest employee grant was 490,843 options, or 295,422 less than what
Rutchik received. Rutchik’s options vested proportionately over a three-year period, and
his unvested options would accelerate and vest upon a change of control. Rutchik’s
options thus had a single trigger for acceleration.
Rich received options on 147,711 shares, the same as the sixth-highest employee
after Stella. His options vested proportionately over a three-year period, and his unvested
options would accelerate and vest upon a change of control. Rich’s options also had a
single trigger for acceleration.
G. The Merger Negotiations And Term Sheet
While these events were transpiring, discussions with Snyk moved forward. By
September 2021, Snyk and the Company were negotiating a merger agreement. In
October, the Board retained an investment banker to conduct a market check in response
to a formal offer from Snyk.
On December 18, 2021, the Board informed the Company’s stockholders that
Snyk had agreed to a term sheet to acquire the Company for $120 million in cash. That
was the first time that the plaintiffs heard about the discussions with Snyk. Before then,
the plaintiffs believed that the Company had abandoned its efforts to find an acquirer in
April and that management was focusing on growing the business.
H. Requests For Information
After learning of the term sheet with Snyk, the plaintiffs requested information
about the timing and terms of the proposed transaction. The Company was evasive.
17
On January 19, 2022, the plaintiffs served a demand to inspect books and records
under Section 220 of the DGCL. The demand expressed concern about the timing of the
Recapitalization and the proposed sale of the Company. At the time, the plaintiffs did not
know about the Second Offering.
The Company reacted angrily to the demand and accused the plaintiffs of
attempting to derail the transaction with Snyk. The Company threatened to sue the
plaintiffs. In a formal response to the demand, the Company claimed that the plaintiffs
lacked a proper purpose for conducting an inspection.
After further back and forth, the Company produced some documents in response
to the demand. The Company failed to produce communications between the Company
and any third party regarding the transaction with Snyk.
I. The Merger
On February 12, 2022, the Company circulated a draft merger agreement to the
plaintiffs along with a joinder agreement and a Section 280G Disclosure Statement and
Voting Form. The Company asked the plaintiffs to sign the joinder agreement and voting
form. The cover email asserted that the plaintiffs were obligated to sign under the terms
of the Drag-Along Provision.
Section 1.1 of the joinder agreement bound the signatory to vote in favor of the
merger with Snyk and against any competing proposal. Section 1.2 of the joinder
agreement caused the signatory to release any and all claims against the Company, the
defendants, and other parties.
18
The plaintiffs offered to sign the documents if Stella and Rich each signed a sworn
affirmation attesting to the fact that they had not had any communications about a
potential transaction with Snyk before the Recapitalization. Their counsel indicated that
they would, and the plaintiffs provided a draft affirmation.
On February 17, 2022, the Company announced that it had entered a merger
agreement with Snyk and closed the transaction (the “Snyk Merger”). At closing, the
Company had $5.5 million in cash on its balance sheet.
On February 18, 2022, after the Snyk Merger closed, counsel to Stella and Rich
proposed a substantially narrower affirmation. Stella was not willing to affirm that (i) he
did not have communications with Snyk outside the ordinary course of business before
the Recapitalization or that (ii) he did not have any communications or enter into any
agreements with any person associated with GRI Ventures, including Rich, about his
personal post-Recapitalization economics or business opportunities that were not
otherwise disclosed to the Board.
That same day, the Company provided an incomplete distribution waterfall
showing only the payments to the plaintiffs. It was not until February 21, 2022, that the
Company provided a full distribution waterfall. That document revealed the existence of
the shares of Preferred Stock issued in the Second Offering.
The waterfall showed that the Rich Entities received $14,570,213.04 in proceeds
for the 3,282,453 shares of the Preferred Stock they had purchased in the Second
Offering for $2,002,296.33, reflecting an increase in value of 728%. The Rutchik Trust
received $1,457,019.97 in proceeds for the 328,245 shares of the Preferred Stock it
19
purchased in the Second Offering for $200,229.45, thereby achieving the same
percentage gain. On a per share basis, the Rich Entities and the Rutchik Trust bought
shares of Preferred Stock at $0.61 per share. Through the Snyk Merger, they sold at $4.44
per share of Preferred Stock.
Stella, Rich, and Ruchik’s options vested as a result of the Snyk Merger. In the
transaction, the common stock was valued at $3.22 per share. Net of the exercise price of
$0.10 per share, the option holders received $3.10 per share. The Interested Grants
generated total net proceeds of $9,623,389.20: Stella received net proceeds of
$6,397,158.18; Rutchik received net proceeds of $2,765,340.43; and Rich received net
proceeds of $460,890.59.
In total, through the Second Offering and the Interested Grants, Rich, Rutchik, and
Stella received $25,650,622.21 in net proceeds from the Snyk Merger.
Part of the defendants’ gains came at the expense of the Company’s other
stockholders. Without the Second Offering and Interested Grants, the merger
consideration that Rich, Rutchik, and Stella received for those shares would have been
available for distribution pro rata to all of the stockholders. Yes, the Rich Entities and the
Rutchik Trust would have received their proportionate share based on the Preferred Stock
they acquired in the Recapitalization, but their pro rata share would have been a fraction
of the amounts they extracted through the Second Offering and the Interested Grants.
Through those transactions, the Rich Entities and the Rutchik Trust increased their net
take at the expense of the Company’s other stockholders. Through the Interested Grants,
Stella gained all of the equity interests that provided him with a share of the merger
20
consideration. In the Legal Analysis, infra, this decision provides rough estimates of the
amount of the diverted proceeds.
J. This Litigation
On May 9, 2022, NEA and Core Capital filed this lawsuit. The operative
complaint contains eight counts.
Counts I and II concern the Investor ROFO. Count I asserts that the Company
breached the Management Rights Letter by failing to comply with the Investor ROFO.
NEA contends that the complaint failed to provide notice of the Second Offering and did
not permit NEA to participate in the Second Offering. Count II asserts that the Rich
Entities and the Rutchik Trust tortiously interfered with the Management Rights Letter by
participating in the Company’s breach of the Investor ROFO.
Counts III, IV, and V assert claims based on the duty of disclosure. Count III
alleges that Rich, Rutchik, and Stella breached their duty of disclosure as directors by
failing to disclose Snyk’s inquiry when soliciting stockholder approval for the Charter
Amendment. Count IV alleges that the Rich Entities breached their duties as controlling
stockholders by failing to disclose the Snyk inquiry in connection with stockholder
approval of the Charter Amendment. Count IV alleges that the Rutchik Trust aided and
abetted the fiduciaries’ breaches of duty. The same counts advance similar disclosure
claims directed at the Option Grants.
Counts VI, VII, and VIII challenge the Snyk Merger. Count VI contends that Rich,
Rutchik, and Stella breached their fiduciary duties as directors by approving the Snyk
Merger. Count VII advances a similar theory against the Rich Entities for breaching their
21
fiduciary duties as controlling stockholders. Count VIII alleges that the Rutchik Trust
aided and abetted the fiduciaries’ breaches of duty.
The defendants have moved to dismiss the complaint in its entirety. They argue
that the complaint’s allegations fail to state claims on which relief can be granted. They
also contend that the Covenant Not To Sue bars the plaintiffs from asserting their claims.
This decision addresses the first issue. The court will address the Covenant Not To Sue
separately.
II. LEGAL ANALYSIS
The defendants have moved to dismiss the complaint under Rule 12(b)(6) on the
grounds that it fails to state a claim on which relief can be granted. When considering a
Rule 12(b)(6) motion, the court (i) accepts as true all well-pleaded factual allegations in
the complaint, (ii) credits vague allegations if they give the opposing party notice of the
claim, and (iii) draws all reasonable inferences in favor of the plaintiffs. Cent. Mortg. Co.
v. Morgan Stanley Mortg. Cap. Hldgs. LLC, 27 A.3d 531, 535 (Del. 2011). Dismissal is
inappropriate “unless the plaintiff would not be entitled to recover under any reasonably
conceivable set of circumstances.” Id.A. Count I: Breach Of The Investor ROFO
In Count I of the complaint, NEA asserts a claim against the Company for breach
of the Investor ROFO. The Company’s motion to dismiss Count I is denied.
“In alleging a breach of contract, a plaintiff need not plead specific facts to state an
actionable claim.” VLIW Tech., LLC v. Hewlett-Packard Co., 840 A.2d 606, 611 (Del.
2003). At the motion to dismiss stage, it is sufficient to simply allege “first, the existence
22
of the contract . . .; second, the breach of an obligation imposed by that contract; and
third, the resultant damage to the plaintiff.” Id. at 612. So long as the complaint alleges
that an “agreement[] ha[s] been breached,” and even if it is not clear that the non-
breaching party has “suffer[ed] immediate quantifiable harm, the equitable powers of this
Court afford [it] broad discretion in fashioning appropriate relief.” Universal Studios Inc.
v. Viacom Inc., 705 A.2d 579, 583 (Del. Ch. 1997). It is thus more accurate to describe
the elements of a claim for breach of contract as “(i) a contractual obligation, (ii) a breach
of that obligation by the defendant, and (iii) a causally related injury that warrants a
remedy, such as damages or in an appropriate case, specific performance.” AB Stable VIII
LLC v. Maps Hotels & Resorts One LLC, 2020 WL 7024929, at *47 (Del. Ch. Nov. 30,
2020), aff’d, 268 A.3d 198 (Del. 2021).
Count I satisfies each of these elements. The complaint alleges that NEA was a
party to the Management Rights Letter which contained the Investor ROFO. That
provision in turn granted NEA a ROFO on any “New Securities.” Although the
Management Rights Letter did not define that term, the Fourth Amended and Restated
Investors’ Rights Agreement (the “Investors’ Rights Agreement”) defined New Securities
as, “collectively, equity securities of the Company, whether or not currently authorized,
as well as rights, options, or warrants to purchase such equity securities, or securities of
any type whatsoever that are, or may become, convertible or exchangeable into or
exercisable for such equity securities.” Ex. 1, Ex. D at 5. The Company issued new shares
of Preferred Stock in the Second Offering, which qualified as New Securities. The
Company failed to provide NEA with the notice and opportunity to participate that the
23
Investor ROFO required. NEA was damaged because it was deprived of the opportunity
to purchase its pro rata share of New Securities before the sale of the Company to Snyk.
The Company does not argue that NEA has failed to plead the elements of a claim
for breach of contract. Instead, the Company advances two arguments for dismissal.
The first is an extreme interpretation of the Investor ROFO under which the
Company had no obligation to give notice of the Second Offering until after that
transaction closed. At that point, NEA could not participate in the transaction, so the
Investor ROFO could not have been breached.
In reasoning its way to this nonsensical result, the Company observes that the Rich
Entities, defined as the “Major Investors,” possessed a ROFO right of their own under the
Investors’ Rights Agreement.13 The Investor ROFO states that if the Rich Entities waive
their ROFO, then that waiver also applies to NEA’s ROFO. But that knock-on waiver is
subject to an exception: If the Rich Entities go ahead and purchase New Securities
notwithstanding their waiver, then the Investor ROFO is reactivated. In other words, the
Rich Entities cannot formally waive their ROFO so that NEA loses the Investor ROFO,
only to exercise their power over the Company to ensure that they could purchase New
Securities notwithstanding the waiver. Focusing intently on the language of the
exception, the Company notes that it technically provides that in such a case, “the
13
The Investors’ Rights Agreement defined “Major Investors” as the Lead
Investor (i.e., GRI Ventures) plus any other investor that owned at least 1,641,227 shares
of Preferred Stock. Ex. 1, Ex. D at 4. Only JMI Fugue, the second of the two Rich
Entities, qualified.
24
Company shall provide the investor the notice of such purchase of New Securities by the
Major Investors and the Investor shall be entitled to participate in such Financing
Transaction in accordance with the terms and conditions of [the Investor ROFO].” Ex. 1,
Ex. G at 4. According to the Company, notice of the “purchase” means notice that the
purchase is complete. The Company claims that notice of the “purchase” does not require
notice of the Company’s “intention to offer” New Securities. And once the purchase is
complete (says the Company), the deal is done, and NEA has no means of enforcing its
rights under the Investor ROFO.
Only a litigator reading a contract after a dispute has arisen with the goal of
coming up with arguments for a client could embrace that degree of literalism. The
obvious intent of the exception is to permit NEA to “participate in such Financing
Transaction,” which NEA cannot do if the transaction has closed and all of the securities
have been purchased. The plain meaning of the provision is to reactivate the Investor
ROFO by requiring the Company to give notice of the fact that the Rich Entities are
purchasing securities notwithstanding their waiver of their own ROFO. The Company
had an obligation to give notice so that NEA could exercise the Investor ROFO and
participate. The Company failed to provide the necessary notice.
The Company’s only other argument for dismissal is that the closing of the Snyk
Merger terminated the Management Rights Letter and, therefore, terminated NEA’s
ability to bring a claim based on the Company’s pre-termination breach of the Investor
ROFO. That argument falls short as well.
25
The parties joust over whether the Management Rights Letter should have
contained additional language that specified the consequences of termination. The
Company argues that if NEA wanted to preserve its ability to sue for a pre-termination
breach, then it should have included language to that effect. NEA responds that the
obligation to include additional language runs the other way, such that if the Company
wanted to eliminate liability for a prior breach, then the Company had to include
language to that effect.
Parties can always contract for specific results. Those outcomes may confirm or
comport with the default principles of law, or they may depart from the default principles
of law. Parties negotiate in the shadow of default principles of law, and if a contract is
silent, then default principles apply. When interpreting contract language, it is therefore
important to know what common law rule otherwise would apply. Sometimes, contract
language will track or closely resemble default principles of law, thereby enabling a court
to reject a contrary interpretation of settled language that one side or the other has
advanced. E.g., Warner Commc’ns Inc. v. Chris-Craft Indus., Inc., 583 A.2d 962, 969
(Del. Ch. 1989) (Allen, C.) (interpreting term of preferred stock to provide for same
result as Section 242(b)(2) of the DGCL). In other cases, comparing the contract
language to the default outcome will demonstrate that the plain meaning of the language
calls for a different result. Either way, knowing what would happen if the contract were
silent is helpful in determining plain meaning.
Under the common law default rule, the termination of a contract “results in an
agreement becoming void, but that fact alone does not eliminate liability for a prior
26
breach.” AB Stable, 2020 WL 7024929, at *103 (noting the common law rule that an
injured party may claim damages following a contractual breach and termination); accord
23 Williston on Contracts § 63.3; 3 Farnsworth on Contracts § 12.09, at 12-79. In order
to depart from the common law rule and eliminate liability for a pre-termination breach,
the contract must contain language to that effect, such as a provision stating that “[i]n the
event of termination . . ., this Agreement shall forthwith become void and there shall be
no liability on the part of either party . . . .”14
The Management Rights Letter does not contain language waiving the Company’s
liability for a pre-termination breach. The Management Rights Letter states that “[t]he
rights described herein shall terminate and be of no further force or effect upon . . .
14
AB Stable, 2002 WL 7024929, at *103; accord Yatra Online, Inc. v. Ebix, Inc.,
2021 WL 3855514, at *9 (Del. Ch. Aug. 30, 2021), aff’d, 276 A.3d 476 (Del. 2022); In re
Anthem-Cigna Merger Litig., 2020 WL 5106556, at *133 (Del. Ch. Aug. 31, 2020), aff’d,
251 A.3d 1015 (Del. 2021); see ABA Mergers & Acqs. Comm., Model Tender Offer
Agreement 240 (2020) (discussing exceptions to a provision contemplating no liability
upon termination and stating that “[w]ithout this proviso, the language in Section 8.02
would provide that neither party would be liable for breach to the other after termination,
regardless of pre-closing breaches”); Kling & Nugent, supra, § 15A.02 at 15A-4.3
(noting the effect of a broad elimination of liability upon termination and suggesting that
“[it] is important . . . to continue and carve out a proviso to the effect that the foregoing
will not relieve any party for liability for its breach of any provision prior to
termination”). Cf. ABA Mergers & Acqs. Comm., Model Stock Purchase Agreement with
Commentary 280–81 (2d ed. 2010) (discussing effect-of-termination provision that did
not contain liability-extinguishing language but did contain an exception for specified
provisions as well as confirmatory language stating that “termination of this Agreement
will not relieve a party from any liability for any Breach of this Agreement occurring
prior to termination”); ABA Mergers & Acqs. Comm., Model Asset Purchase Agreement
with Commentary 199 (2001) (discussing effect-of-termination provision without
liability-extinguishing language and with confirmatory language stating that “the
terminating party’s right to pursue all legal remedies will survive such termination
unimpaired”).
27
consummation of a merger,” but that is forward-looking language designed to address
post-merger enforcement. Absent that language, the Management Rights Letter would
become an obligation of the surviving company, and the Investor ROFO would apply to
issuances of the surviving company’s securities. See 8 Del. C. § 259 (providing that
following a merger, “all debts, liabilities and duties of the respective constituent
corporations shall thenceforth attach to said surviving or resulting corporation, and may
be enforced against it to the same extent as if said debts, liabilities and duties had been
incurred or contracted by it”). The quoted language says nothing about extinguishing
liability for a pre-termination breach.
To argue for a different result, the Company cites a leading treatise on mergers
and acquisitions which recommends that parties who wish to avoid having a termination
provision extinguish their claims “carve out a proviso to the effect that the foregoing will
not relieve any party for liability for its breach of any provision prior to termination” so
as to avoid being left “without a remedy.” Dkt. 13 at 29 (citing Kling & Nugent, supra, §
15A.02 at 15A-4.3). That recommendation appropriately encourages parties to use
specific language in a contract to identify the outcome they want to achieve. It does not
take the position that under the common law, the termination of an agreement broadly
extinguishes the parties’ liability for pre-termination breaches. To the contrary, the only
example that the treatise cites for the effect of termination on liability for pre-termination
breaches is the Yatra decision, where the contract at issue specifically provided that upon
termination, “there shall be no liability on the part of any party with respect thereto,
except for [specified provisions] . . . and that nothing contained herein shall relieve any
28
party from liability for damages arising out of any fraud occurring prior to such
termination.” Yatra, 2021 WL 3855514, at *7. The agreement in Yatra contained
liability-eliminating language, which this court enforced. The Management Rights Letter
does not contain similar language.
Count I states a claim on which relief can be granted.
B. Count II: Tortious Interference With Contract
In Count II of the complaint, NEA asserts a claim against the Rich Entities and the
Rutchik Trust for tortiously interfering with the Management Rights Letter. This count
also states a claim on which relief can be granted.
Delaware has adopted the formulation of a claim for tortious interference with
contract that appears in the Restatement (Second) of Torts. WaveDivision Hldgs., LLC v.
Highland Cap. Mgmt., L.P., 49 A.3d 1168, 1174 (Del. 2012); ASDI, Inc. v. Beard Rsch.,
Inc., 11 A.3d 749, 751 (Del. 2010). Generally speaking, “[o]ne who intentionally and
improperly interferes with the performance of a contract . . . between another and a third
person by inducing or otherwise causing the third person not to perform the contract, is
subject to liability to the other.” Restatement (Second) of Torts § 766 (Am. L. Inst. 1979),
Westlaw (database updated Oct. 2022) [hereinafter Restatement]. Reframed as elements,
a plaintiff must plead “(1) a contract, (2) about which defendant knew, and (3) an
intentional act that is a significant factor in causing the breach of such contract, (4)
without justification, (5) which causes injury.” Bhole, Inc. v. Shore Invs., Inc., 67 A.3d
444, 453 (Del. 2013) (internal quotation marks omitted).
29
In this case, the complaint easily pleads three of the five elements of a claim for
tortious interference with contract. There was a contract (the Management Rights Letter).
This decision has concluded that it is reasonably conceivable that the Investor ROFO was
breached, causing injury to NEA. Rich and Rutchik plainly knew about the contract, and
their knowledge is imputed to the Rich Entities and the Rutchik Trust, respectively.15
The first of the two remaining elements is the existence of an intentional act that is
a significant factor in causing the breach. To plead a claim against the Rich Entities and
the Rutchik Trust, the plaintiffs must plead an intentional act by those entities. NEA
alleges that the Rich Entities and the Rutchik Trust acted by written consent to approve
the Charter Amendment that was necessary to effectuate the Second Offering, failed to
cause the Company to provide the Investor ROFO notice to NEA, then purchased a
15
See, e.g., Tchrs.’ Ret. Sys. of La. v. Aidinoff, 900 A.2d 654, 671 n.23 (Del. Ch.
2006) (“[I]t is the general rule that knowledge of an officer or director of a corporation
will be imputed to the corporation.”); Albert v. Alex. Brown Mgmt. Servs., Inc., 2005 WL
2130607, at *11 (Del. Ch. Aug. 26, 2005) (imputing knowledge of member-employees to
limited liability companies); Metro Commc’n Corp. BVI v. Advanced Mobilecomm Techs.
Inc., 854 A.2d 121, 153–55 (Del. Ch. 2004) (imputing fraud claims to corporation where
it designated a manager of a limited liability company and where the manager made
fraudulent statements); Nolan v. E. Co., 241 A.2d 885, 891 (Del. Ch. 1968) (“Knowledge
of an agent acquired while acting within the scope of his authority is imputable to the
principal.”), aff’d, 249 A.2d 45 (Del. 1969); see also 3 William Meade Fletcher, Fletcher
Cyclopedia of the Law of Corporations § 790, at 16–20 (perm ed., rev. vol. 2011),
Westlaw (database updated Sept. 2022) (“[T]he general rule is well established that a
corporation is charged with constructive knowledge . . . of all material facts of which its
officer or agent receives notice or acquires knowledge [of] while acting in the course of
employment within the scope of his or her authority, even though the officer or agent
does not in fact communicate the knowledge to the corporation.” (footnote omitted)).
30
majority of the shares of Preferred Stock that comprised the Second Offering. See Compl.
¶¶ 96–103. At the pleading stage, those steps supply the requisite intentional act.
The Rich Entities and the Rutchik Trust respond that they instructed the
Company’s managers to provide notice to NEA and other non-consenting stockholders.
They rely on the Written Consent itself, which provides that “the appropriate officers or
officers [sic] of the Corporation . . . shall be, and hereby are, authorized, empowered and
directed to give notice of the corporate actions specified above, in accordance with
Section 228(e) of the DGCL, to those stockholders who have not consented in writing
hereto.” Ex. 3 at 3. That language is not about the notice required by the Investor ROFO.
It refers expressly to a statutory requirement found in Section 228(e), which states:
Prompt notice of the taking of the corporate action without a meeting by
less than unanimous written consent shall be given to those stockholders or
members who have not consented in writing and who, if the action had
been taken at a meeting, would have been entitled to notice of the meeting
if the record date for notice of such meeting had been the date that written
consents signed by a sufficient number of holders or members to take the
action were delivered to the corporation as provided in subsection (c) of
this section
8 Del. C. § 228(e). An instruction to fulfill the statutory notice requirement is not an
instruction to fulfill the Investor ROFO’s notice requirement.
In any event, the complaint sufficiently pleads that the Company did not comply
with the Section 228(e) notice requirement. NEA and Core Capital allege that they did
not learn about the Second Offering until they requested books and records months later,
after learning of the Snyk Merger. Compl. ¶ 65.
31
Rich and Rutchik constituted a majority of the Board. As such, they were
responsible for ensuring that the Company fulfilled its contractual obligations under the
Investor ROFO and its statutory obligations under Section 228(e). As directors
constituting a majority of the Board, Rich and Rutchik determined who would be able to
purchase shares of Preferred Stock in the Second Offering and how many shares they
would get. See Ex. 2. Only ten investors received the right to purchase shares. Four of the
purchasers were the Rich Entities, Rutchik, and a person who is inferably Rich’s son
(George Rich, Jr.). Those four acquired 83% of the 3,938,941 shares of Preferred Stock
issued in the Second Offering. The Rich Entities alone acquired 71% of the issuance.
They made these purchases despite knowing that the Company was obligated to offer the
New Securities first to NEA. It is reasonable to infer that the Rich Entities and the
Rutchik Trust acted in conjunction with their representatives on the Board to implement
the Second Offering in a manner that interfered with the Company’s ability to offer to
NEA the share of the New Securities to which NEA was contractually entitled. Those
allegations are sufficient to plead that the Rich Entities and the Rutchik Trust
intentionally acted in a manner that contributed to the breach of the Investor ROFO.
The final element is the existence of justification. “The tort of interference with
contractual relations is intended to protect a promisee’s economic interest in the
performance of a contract by making actionable ‘improper’ intentional interference with
the promisor’s performance.” Shearin v. E.F. Hutton Gp., 652 A.2d 578, 589 (Del. Ch.
1994). “The adjective ‘improper’ is critical. For participants in a competitive capitalist
economy, some types of intentional interference with contractual relations are a
32
legitimate part of doing business.” NAMA Hldgs., LLC v. Related WMC LLC, 2014 WL
6436647, at *26 (Del. Ch. Nov. 17, 2014). “[C]laims for unfair competition and tortious
interference must necessarily be balanced against a party’s legitimate right to compete.”
Agilent Techs. v. Kirkland, 2009 WL 119865, at *8 (Del. Ch. Jan. 20, 2009). Determining
when intentional interference becomes improper requires a “complex normative
judgment relating to justification” based on the facts of the case and “an evaluation of
many factors.” Shearin, 652 A.2d at 589 (internal quotation marks omitted).
The Delaware Supreme Court has adopted the factors identified in Section 767 of
the Restatement as considerations to weigh when evaluating the existence of justification.
WaveDivision, 49 A.3d at 1174. The factors are:
(a) the nature of the actor’s conduct, (b) the actor’s motive, (c) the interests
of the other with which the actor’s conduct interferes, (d) the interests
sought to be advanced by the actor, (e) the social interests in protecting the
freedom of action of the actor and the contractual interests of the other, (f)
the proximity or remoteness of the actor’s conduct to the interference and
(g) the relations between the parties.
Id. Weighing the seven factors identified in the Restatement requires the court to engage
in a fact-specific inquiry to determine whether the interference with contract is improper
under the particular circumstances of the case. See Restatement, supra, § 767 cmt. b
(“[T]his branch of tort law has not developed a crystallized set of definite rules as to the
existence or non-existence of a privilege . . . . Since the determination of whether an
interference is improper is under the particular circumstances, it is an evaluation of these
factors for the precise facts of the case before the court.”).
33
When the defendants that a plaintiff has sued for tortious interference control an
entity that was a party to the contract, the weighing of factors becomes more complex
because of the need to balance the policies served by a claim for tortious interference
with contract against the policies served by the corporate form.
Ordinarily, of course, only property belonging to the corporation [that is the
party to the contract] is available to satisfy obligations of the corporation.
Thus, while there may be independent grounds to hold another liable for the
obligations of a corporation . . . [,] those in control of a corporation are not
typically liable for distinctly corporate obligations by reason of that control.
This “fact,” of course, supplies one of the principal utilities of the corporate
form of organization.
Irwin & Leighton, Inc. v. W.M. Anderson Co., 532 A.2d 983, 987 (Del. Ch. 1987)
(internal citations omitted). A party who wishes to have a parent entity or other controller
backstop the obligations of the controlled entity can do so by contract, either by making
the parent a party to the agreement or by obtaining a guarantee. A party should not be
able to use a claim of tortious interference with contract to reap the benefits of
protections that it did not obtain at the bargaining table.
At the same time, Delaware’s respect for corporate separateness means that
Delaware maintains a role for tortious interference even when one entity controls another.
For example, Delaware law rejects the theory that “a parent and its wholly owned
subsidiaries constitute a single economic unit” such that “a parent cannot be liable for
interfering with the performance of a wholly owned subsidiary.” Shearin, 652 A.2d at
590; accord Allied Cap. Corp. v. GC-Sun Hldgs., L.P., 910 A.2d 1020, 1038 (Del. Ch.
2006). Delaware law instead balances “the significant economic interest of a parent
corporation in its subsidiary,” including the parent’s legitimate interest in consulting with
34
its subsidiary, against the subsidiary’s status as a separate entity and the interests of third
parties in their contractual relationships with the subsidiary. Shearin, 652 A.2d at 590.
The result is a limited affiliate privilege that protects a parent corporation that “pursues
lawful action in the good faith pursuit of [the subsidiary’s] profit making activities.” Id.Recognizing a limited affiliate privilege is “consistent with the traditional respect
accorded to the corporate form by Delaware law . . . in that it does not ignore that a
parent and a subsidiary are separate entities. Rather, it recognizes that the close economic
relationship of related entities requires enhanced latitude in defining what ‘improper’
interactions would be.” Id. at 590 n.13 (internal citation omitted).
Here, because of the fact-intensive nature of this inquiry, it is not possible to
determine at the pleading stage whether the Rich Entities and the Rutchik Trust acted
with justification when they participated in the breach the of the Investor ROFO. By
acting as they did, the Rich Entities and Rutchik gobbled up 82% of the Second Offering
while paying the same price that Rich had extracted months earlier when the Company
needed cash. By acquiring more Preferred Stock at what was inferably an undervalued
price, the Rich Entities and Rutchik gained a greater ownership interest in the Company
at a low basis, setting themselves up to cash in if there was a liquidity event.
It is reasonable to infer that by proceeding in this fashion, the Rich Entities and
Rutchik did not cause the Company to pursue legitimate profitmaking activities. It was all
the same for the Company whether the Rich Entities, Rutchik, or NEA bought the shares
of Preferred Stock in the Second Offering. By acting as they did, the Rich Entities and the
Rutchik Trust pursued their own advantage. If anything, they acted contrary to the
35
Company’s legitimate profitmaking activities, because the Company had an interest in
selling the Preferred Stock for a higher price than Rich had extracted when the Company
was in desperate straits. Based on these pled facts, it is reasonably conceivable that the
Rich Entities and the Rutchik Trust acted without justification.
NEA has pled a claim for tortious interference with contract against the Rich
Entities and the Rutchik Trust.
C. Count III: The Claim Against The Directors For Breach Of The Duty Of
Disclosure In Connection With The Second Offering And Option Grants
In Count III of the complaint, NEA and Core Capital allege that Rich, Rutchik,
and Stella breached their fiduciary duty of disclosure when seeking stockholder approval
for the Second Offering and the Option Grants. The disclosure claim regarding the
Option Grants is dismissed because the Option Grants did not involve any stockholder
action or other identifiable disclosure issue. The disclosure claim regarding the Second
Offering states a claim on which relief can be granted, but it is a derivative claim that the
plaintiffs lost standing to pursue as a result of the Snyk Merger.
1. The Pertinent Parameters Of The Duty Of Disclosure
Directors of a Delaware corporation owe two fiduciary duties: care and loyalty.
Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006). The duty
of disclosure is not an independent duty, but rather arises as “the application in a specific
context of the board’s fiduciary duties . . . .” Malpiede v. Townson, 780 A.2d 1075, 1086
(Del. 2001).
36
The scope and requirements of the duty of disclosure depend on context. Stroud v.
Grace, 606 A.2d 75, 85 (Del. 1992). When confronting a disclosure claim, a court
therefore must engage in a context-specific analysis to determine the source of the duty,
its requirements, and any remedies for breach. See Lawrence A. Hamermesh, Calling Off
the Lynch Mob: The Corporate Director’s Fiduciary Disclosure Duty, 49 Vand. L. Rev.
1087, 1099 (1996). “Governing principles have been developed for recurring scenarios,
four of which are prominent.” In re Wayport, Inc. Litig., 76 A.3d 296, 314 (Del. Ch.
2013). Two of those scenarios are potentially present in this case.
The first involves a request for stockholder action. When directors submit to the
stockholders a transaction that requires stockholder approval (such as a merger, sale of
assets, or charter amendment) or which requires a stockholder investment decision (such
as tendering shares or making an appraisal election), the directors have a duty to provide
the stockholders with all material information reasonably available to them. Pfeffer v.
Redstone, 965 A.2d 676, 686 (Del. 2009); Delman v. GigAcquisitions3, LLC, --- A.3d ---,
---, 2023 WL 29325, at *24 (Del. Ch. Jan. 4, 2023); Wayport, 76 A.3d at 314.
The second scenario involves a corporate fiduciary who speaks outside of the
context of soliciting or recommending stockholder action, such as through “public
statements made to the market,” “statements informing shareholders about the affairs of
the corporation,” or public filings required by the federal securities laws. Malone v.
Brincat, 722 A.2d 5, 11 (Del. 1998). “In that context, directors owe a duty to
stockholders not to speak falsely.” Wayport, 76 A.2d at 315.
37
Whenever directors communicate publicly or directly with shareholders
about the corporation’s affairs, with or without a request for shareholder
action, directors have a fiduciary duty to shareholders to exercise due care,
good faith and loyalty. It follows a fortiori that when directors
communicate publicly or directly with shareholders about corporate matters
the sine qua non of directors’ fiduciary duty to shareholders is honesty.
Malone, 722 A.2d at 10; accord id. at 10–11 (“Shareholders are entitled to rely upon the
truthfulness of all information disseminated to them by the directors they elect to manage
the corporate enterprise.”). “[D]irectors who knowingly disseminate false information
that results in corporate injury or damage to an individual stockholder violate their
fiduciary duty, and may be held accountable in a manner appropriate to the
circumstances.” Id. at 9; accord id. at 14 (“When the directors are not seeking
shareholder action, but are deliberately misinforming shareholders about the business of
the corporation, either directly or by a public statement, there is a violation of fiduciary
duty.”).
The plaintiffs have identified reasons why the duty of disclosure could apply to the
Second Offering. Most clearly, there was a request for stockholder action. To facilitate
that issuance, the Company needed more authorized shares of Preferred Stock, which
necessitated the Charter Amendment. As discussed in the Factual Background, the
Charter Amendment required three votes: (i) an affirmative vote from holders of a
majority of the voting power of the Preferred Shares and the common shares voting
together as a single class, (ii) an affirmative vote from holders of a majority of the voting
power of the Preferred Shares voting as a single class, and (iii) an affirmative vote from
38
holders of a majority of the voting power of the Preferred Shares excluding the shares
held by the Rich Entities, voting as a separate class.
As the holders of a majority of the Preferred Stock, the Rich Entities could deliver
the second vote themselves. Together, the entities that Rich and Rutchik controlled held
shares with 44% of the Company’s voting power, so they could almost deliver the first
vote. Where they needed help was the third vote, where the Rich Entities’ votes did not
count. And if they secured that vote, then they would have more than enough votes to
clear the first vote.
To secure the votes they needed, the directors solicited seventeen other holders of
Preferred Stock. The ten Other Signatories signed the Written Consent. The seven Non-
Signatories did not sign the Written Consent. The request to sign the Written Consent
was a request for stockholder action to which the duty of disclosure applies.
The plaintiffs also argue that Stella previously had told the Board in April 2021
that the Company had failed to identify any potential acquirers, was shutting down its
process, and would spend the next two to three years building its business before
exploring a sale. The plaintiffs argue that when speaking in connection with the Second
Offering, the directors had an obligation to update that prior disclosure, which had
become false in light of the Snyk inquiry. See Wayport, 76 A.3d at 324 (discussing duty
to update). What the plaintiffs have not done is to identify any occasion on which the
directors spoke except through the solicitation of the Written Consent. The duty of
disclosure in connection with a request for stockholder action is broader than the more
39
general duty to speak honestly and completely, so there is no need to analyze the separate
theory.
The plaintiffs have not identified any basis for a disclosure claim in connection
with the Option Grants. The Written Consent does not contain any reference to the
Option Grants, and the plaintiffs have not identified any other source of stockholder
action that could relate to the Option Grants. They also have not pointed to any
statements by the directors regarding the Option Grants. To the extent Count III pertains
to the Option Grants, the claim is dismissed.
2. The Disclosure-Based Challenge To The Second Offering
The plaintiffs contend that the directors breached their duty of disclosure when
asking the Other Signatories to execute the Written Consent. This claim advances a novel
theory, because the plaintiffs are not arguing that the directors breached their duty of
disclosure when making disclosures to them or when seeking their vote. They are seeking
to litigate the sufficiency of the disclosures that the directors provided to the Other
Signatories. Although novel, this theory is viable under Delaware law.
a. The Obligation To Make Disclosures When Seeking Consents
From A Limited Number Of Stockholders
A threshold issue is whether Delaware law imposes a duty of disclosure when
directors seek written consents from a limited number of stockholders in a private
company. Precedent demonstrates that the duty exists.
The Delaware Supreme Court’s decision in Stroud is its most significant ruling
about the duty of disclosure in the context of a privately held company. In Stroud, the
40
stockholders in a family-owned corporation were divided into factions, with a large
controlling block and a small minority block. 606 A.2d at 79–80. The controlling
stockholders planned to approve amendments to the corporation’s charter and by-laws at
the annual meeting. Id. They did not need support from the minority to carry the vote,
and the directors did not solicit proxies. Id. at 80. The only information that the directors
provided in advance of the meeting was the statutorily required notice of meeting and a
summary of the proposed charter amendments. Id. at 80, 85. A stockholder plaintiff from
the minority asserted that the board of directors had a fiduciary duty to disclose all
material information, and the Court of Chancery agreed. Id. at 86.
On appeal, the Delaware Supreme Court reversed. The high court acknowledged
that “directors 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.” Id. at 84. But the court held that when directors were not seeking stockholder
action, viz. not soliciting proxies, they only needed to comply with the statutory
requirements of the DGCL. Id. at 87. The corporation had a duty to give notice of the
meeting in compliance with Section 222(a) of the DGCL, and the corporation had a duty
to disclose a summary of the proposed charter amendments as required by Section
242(b)(1) of the DGCL. Id. at 86. The high court rejected the trial court’s view that the
directors had a fiduciary duty to provide all material information reasonably available to
all stockholders. Id. The high court held instead that
under all of the circumstances here, the board had no duty to disclose
anything beyond the requirements of section 242(b)(1) of the General
Corporation Law. The board complied with its statutory duty and included
41
with its notice both the certificates of incorporation and the proposed
amendments. . . . Nor is the board’s conduct inequitable.
Id. at 87. The Delaware Supreme Court admonished the Court of Chancery to “act with
caution and restraint when ignoring the clear language of the General Corporation Law in
favor of other legal or equitable principles.” Id. The Delaware Supreme Court stressed
that its holding was “limited to non-public, privately-held [sic] companies.” Id. at 86.
The Stroud decision involved a situation in which the minority stockholders were
not being asked or required to do anything. Since Stroud, this court has held that the
directors of a privately held company have a duty to disclose all material information
reasonably available to all stockholders when giving stockholders notice of a merger that
would trigger appraisal rights, even if the directors were not seeking any votes. See Nagy
v. Bistricer, 770 A.2d 43 (Del. Ch. 2000); Turner v. Bernstein, 776 A.2d 530 (Del. Ch.
2000). In Turner, the directors of a privately held Delaware corporation controlled a
majority of the corporation’s voting power, and they used their control to cause the
company to sell itself to a third party, with the directors both approving the transaction at
the board level and supplying the necessary stockholder-level consents. 776 A.2d at 534.
After the merger closed, the directors circulated an information statement to enable
stockholders to decide whether to accept the merger consideration or seek appraisal. Id.The information statement provided the stockholders with “extremely cursory
information.” Id. at 532. The directors “did not give the stockholders any current
financial information or explain why the merger was in [their] best interests.” Id. The
stockholders “did not even receive the company’s most recent financial results for the
42
periods proximate to the vote,” nor “any projections of future company performance,”
nor “any explanation of why the [company’s] board believed that the merger
consideration [should be accepted].” Id. at 535. Writing as a Vice Chancellor, Chief
Justice Strine granted summary judgment in favor of the plaintiffs, holding that the duty
to disclose all material information applied and that the directors “defaulted on this
obligation” where they “did not even attempt to put together a disclosure containing any
cogent recitation of the material facts pertinent to the stockholders’ choice.” Id. at 542.
Then-Vice Chancellor Strine reached the same result in Nagy, where the directors
and controlling stockholders of a privately held corporation effected a merger between
the corporation and another entity that they controlled. 770 A.2d at 47. As in Turner, the
defendants distributed a disclosure document that provided minimal information. Chief
Justice Strine observed that “[a]lthough the Information Circular contained a good deal of
information about how to perfect appraisal rights and the nature of an appraisal
proceeding under § 262, the Information Circular was wholly devoid of other material
information.” Id. at 48. He noted that the disclosure document (i) did not provide any
financial information about the buyer or the seller, (ii) did not describe the process or
events leading to the merger, (iii) did not describe why the seller’s board had agreed to
the merger, and (iv) contained no information regarding the fact that the seller’s
controllers held a controlling interest in the buyer. Id. The fact that the defendants had not
solicited the plaintiff’s vote did not foreclose a disclosure claim where the plaintiff had to
decide whether to accept the merger consideration or seek appraisal. Id. at 60.
43
The court took the next step in Kurz v. Holbrook by applying these disclosure
principles to the solicitation of consents by the directors of a privately held company. 989
A.2d 140, 183 (Del. Ch. 2010), aff’d in part, rev’d in part on other grounds sub nom.
Crown EMAK P’rs, LLC v. Kurz, 992 A.2d 377 (Del. 2010). The court explained that
when directors seek stockholder action, the duty of disclosure applies “regardless of
whether a corporation is registered and publicly traded, dark and delisted, or closely
held.” 16 Rather than the duty disappearing,
[w]hat changes is not the underlying duty but rather the context-dependent
analysis of what information is material. Factors such as the nature of the
corporation and its business, the information already available to
stockholders, the other information being provided in the solicitation, and
the type of action being solicited all affect the determination of materiality.
16
Id. In one pre-Kurz decision, the court had identified the issue but declined to
address it. Unanue v. Unanue, 2004 WL 2521292, at *8 (Del. Ch. Nov. 3, 2004). In
Unanue, three branches of a family each effectively controlled one third of the
company’s stock. After the patriarch of one of the branches began acting in an autocratic
manner, the other two branches of the family executed written consents removing him
from his position as a director. Id. at *4. Members of the removed patriarch’s branch
challenged the written consent, contending that the director-representatives of the other
branches failed to disclose all material information when soliciting the written consents
from their family members because they failed to disclose the removed director’s side of
the story. Id. at *4, *8. After discussing Stroud, this court “question[ed] whether
additional disclosure duties [beyond the statutory notice requirement in Section 228(e)]
should be required in the written consent context.” Id. at *9. But this court declined to
address the issue after finding that the nondisclosures were not material on the facts of
the case. Id. at *10. The analogy to Stroud is dubious, because Stroud did not involve a
request for stockholder action. The plaintiffs in Stroud argued that the directors owed
them a duty of disclosure though no one had solicited consents or proxies from them, and
even though they had no decision to make. 606 A.2d at 87. By contrast, another pre-Kurz
decision held that when managers of a closely held LLC solicited a written consent from
one of its members, they acted as fiduciaries and had “a duty to disclose all material facts
bearing on the decision at issue.” Bakerman v. Sidney Frank Importing Co., 2006 WL
3927242, at *14 (Del. Ch. Oct. 10, 2006).
44
Kurz, 989 A.2d at 183.
Since Kurz, this court has acknowledged that the directors of a private company
owe a duty of full disclosure when selectively soliciting consents. Kerbawy v.
McDonnell, 2015 WL 4929198, *12 (Del. Ch. Aug. 18, 2015); see eBay Domestic
Hldgs., Inc. v. Newmark, 16 A.3d 1, 31 (Del. Ch. 2010) (following Kurz in holding that
“[f]iduciary duties apply regardless of whether a corporation is ‘registered and publicly
traded, dark and delisted, or closely held’” (quoting Kurz, 989 A.2d at 183)).
In Kerbawy, a director of a privately held company had assisted the holder of 5%
of the common stock in soliciting consents to remove the incumbent directors and elect a
new board majority. 2015 WL 4929198, at *1–2. The stockholder circulated written
consent materials to a subset of the other stockholders and ultimately delivered to the
company consents from holders of 53% of the outstanding stock. Id. at *11. The
incumbent board majority refused to accept the consents, contending that disclosures that
the director had made to the stockholders were materially misleading. Id. at *1, *5–6. In a
subsequent action under Section 225 of the DGCL to determine the composition of the
board, the court observed that “if a fiduciary breaches his or her disclosure obligations in
connection with soliciting stockholders’ votes or consents, and the Court finds that such
breaches inequitably tainted the election process, that could be grounds for setting aside
otherwise valid votes or consents.” Id. at *12 (cleaned up). The court held that the
director who assisted the stockholder “would be held to a duty of disclosure in this
situation.” Id. at *15. Despite making that observation, the court declined to rule on the
issue because the equities of the case did not support invalidating the consents. Id.
45
Under these authorities, the Company’s directors owed a duty of disclosure when
asking stockholders to execute the Written Consent. That duty required that they provide
the stockholders being solicited with all material information that was reasonably
available, with materiality being judged based on the facts and circumstances facing a
private entity in the Company’s position. The Company’s directors did not owe a duty of
disclosure to the stockholders from whom they did not solicit consents, because those
stockholders were not asked or put in a position where they were required to make any
type of decision that triggered the duty.
b. The Ability To Challenge Disclosures Made To Other
Stockholders
For the plaintiffs, establishing that the Company’s directors owed a duty of
disclosure when they solicited consents only goes part of the way. The plaintiffs must
also establish that a stockholder to whom the directors did not owe a duty of disclosure
can sue a fiduciary for failing to disclose all material information to the stockholders who
were owed that duty. That is a novel issue that differs from the disclosure claim advanced
in Stroud, Kurz, and Kerbawy, because the parties asserting disclosure violations in those
cases contended that they could sue based on the disclosures made or not made to them.
It is also a different issue than in Turner and Nagy, where the plaintiffs had to make an
investment decision.
The defendants advance a straightforward argument against the plaintiffs having
standing to sue: Because no one sought consents from the plaintiffs, they cannot assert a
claim for breach of the duty of disclosure. According to the defendants, only the
46
stockholders who delivered consents can complain about whether or not they were
misled. The plaintiffs are not among the Other Signatories, so they cannot sue.
That position might have merit if the alleged disclosure violations only affected
the stockholders who delivered the consents, but that is not what happens in most
stockholder votes, and it is not what happened in this one. The outcome of a stockholder
vote typically affects non-voting stockholders as well, either because the approval clears
the way for a significant lifecycle event like a merger, sale of assets, and (as here) a
charter amendment,17 or because stockholder approval has effects on the ability of
stockholders to challenge corporate action that was the subject of the vote as void or
voidable,18 or as constituting a breach of fiduciary duty.19
The duty of disclosure protects not just the stockholders whose votes are solicited,
but the overall integrity of the voting process. “What legitimizes the stockholder vote as a
decision-making mechanism is the premise that stockholders with economic ownership
are expressing their collective view as to whether a particular course of action serves the
corporate goal of stockholder wealth maximization.” Kurz, 989 A.2d at 178. The
legitimating conditions for meaningful stockholder voting include aligned economic
incentives, the absence of coercion, “and the presence of full information about the
17
See 8 Del. C. §§ 242(b), 251(c), 271(a).
18
Id. § 144(a).
19
See Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304, 312–13 (Del. 2015); Kahn
v. M & F Worldwide Corp., 88 A.3d 635, 653–54 (Del. 2014).
47
material facts.” Id. The importance of disclosure is so significant that Delaware law
recognizes an exception to the rule that proxies and consents are voted based on the face
of the document: “Where a vote is claimed to have resulted from the commission of a
fraud or breach of fiduciary duty that goes to the very integrity of the election process,
this Court may consider such extrinsic evidence as may be relevant to prove the fraud or
breach of duty.”20
Cases from a related area illustrate these principles. In cases where non-tendering
stockholders have claimed that fiduciaries breached their duty of disclosure in connection
with tender offers, the defendants have argued that because the non-tendering plaintiffs
were not misled into tendering their shares, they could not assert disclosure claims. In a
series of cases, Chancellor Allen rejected that argument, explaining that “a nontendering
shareholder may suffer an injury, and therefore may state a claim upon which relief will
be granted, when, as alleged, false information and omissions led others to tender their
shares.”21 The principal difference between a tender offer and this case is that a non-
20
Parshalle v. Roy, 567 A.2d 19, 24 n.4 (Del. Ch. 1989); id. at 24 (noting the
exception to the face-of-the-ballot rule that applies “where the challenged vote is claimed
to be a result of fraud or breach of duty”); accord Staub v. Reading & Bates Corp., 1991
WL 1182613, at *2 (Del. Ch. Dec. 26, 1991) (explaining that a court can look beyond a
facially valid proxy in instances involving “fraud or breach of duty”); see Blasius Indus.
Inc. v. Atlas Corp., 564 A.2d 651, 670 (Del. Ch. 1989) (Allen, C.) (explaining that
“judges of election (and reviewing courts absent fraud or breach of duty) are not to
inquire into [a record owner’s] intention except as expressed on the face of the proxy,
consent, or other ballot”); id. (stating that “absent fraud, or breach of duty, effect must be
given to properly submitted proxies that are not inconsistent”).
21
Freedman v. Rest. Assocs. Indus., Inc., 1990 WL 135923, *8 (Del. Ch. Sept. 19,
1990) (Allen, C.) (cleaned up); see Cinerama, Inc. v. Technicolor, Inc., 1991 WL
48tendering stockholder knows what disclosures were made to the stockholders who
tendered and can more easily plead a disclosure claim. In both settings, the stockholder
that did not act in response to the disclosure violations is injured by actions that other
stockholders were induced to take. That is true whether the stockholder who did not act
was given the opportunity to make a decision (as in the tender offer context) or was not
(as in this case).
The plaintiffs therefore have standing to challenge the disclosures that the
directors provided to the Other Signatories.
c. Whether The Snyk Inquiry Was Material Information
The plaintiffs contend that the directors breached their duty of disclosure by
failing to inform the Other Signatories about Snyk’s inquiry to Stella. This claim survives
111134, at *21 (Del. Ch. June 24, 1991) (Allen, C.) (noting that because the plaintiff did
not tender, it was not misled by any disclosure violations, but nevertheless could
challenge the adequacy of the disclosure where “[i]t was plainly, though indirectly,
affected by the tender offer [because it] was that transaction that put MAF in a position to
exercise cash-out rights under Section 253 of the Delaware Corporation Law”)
(subsequent history omitted). In Freedman, Chancellor Allen noted that a non-tendering
plaintiff is plainly injured by misleading disclosures in a tender offer that enables the
tender offeror to acquire control. 1990 WL 135923, at *8. He held open the question of
“[w]hether it is true that a non-tendering shareholder may be injured by
misrepresentations in a tender offer made by an offeror who already has control is a
different matter.” Id. Here, the injury arises not because of a change of control, but rather
through the Second Offering that the solicited consents enabled to take place. The actions
of the consenting holders of Preferred Stock thus inflicted an injury directly on the
Company and indirectly on the plaintiffs.
49
because it is not possible to determine as a matter of law that the Snyk inquiry was
immaterial on the facts alleged in the complaint.
Delaware law follows the federal standard for materiality. Rosenblatt v. Getty Oil
Co., 493 A.2d 929, 944 (Del. 1985) (adopting materiality standard from TSC Industries,
Inc. v. Northway, Inc., 426 U. S. 438 (1976)). Information is material if it “‘would have
assumed actual significance in the deliberations’ of a person deciding whether to buy,
sell, vote, or tender stock.” In re Oracle Corp., 867 A.2d 904, 934 (Del. Ch. 2004)
(quoting Rosenblatt, 493 A.2d at 944), aff’d, 872 A.2d 960 (Del. 2005) (TABLE). The
test does not require a substantial likelihood that the information would have caused the
reasonable investor to act differently, such as by changing his vote or opting not to buy,
sell, or tender stock. Rather, the question is whether there is “a substantial likelihood that
the disclosure of the omitted fact would have been viewed by the reasonable investor as
having significantly altered the ‘total mix’ of information made available.” Rosenblatt,
493 A.2d at 944 (cleaned up). At the pleading stage, the operative question is whether the
complaint “supports a rational inference that material facts were not disclosed or that the
disclosed information was otherwise materially misleading.” Morrison, 191 A.3d at 282.
The resulting inquiry necessarily is “fact-intensive, and the Court should deny a motion
to dismiss when developing the factual record may be necessary to make a materiality
determination as a matter of law.” Chester Cnty. Empls.’ Ret. Fund v. KCG Hldgs., Inc.,
2019 WL 2564093, at *10 (Del. Ch. June 21, 2019).
The defendants argue that the Snyk inquiry was too preliminary to constitute
material information that the directors have a duty to disclose. If the Company were
50
publicly traded, then that argument would prevail. But because the Company was a small,
privately held entity that had recently ended a sale process and told its stockholders that a
transaction was not likely to happen for two to three years, it is not possible to determine
at this stage that the Snyk inquiry was immaterial as a matter of law.
In cases involving publicly traded companies, Delaware decisions have held that
when the duty of disclosure applies, directors must provide stockholders with an accurate,
full, and fair description of significant meetings or other interactions between target
management and a bidder.22 That includes material interactions between the target and
the bidder that take place before key agreements are reached.
22
See, e.g., Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1280–82 (Del.
1994) (reversing a grant of summary judgment in favor of defendants on disclosure claim
where proxy failed to disclose the existence of a bid because “once defendants traveled
down the road of partial disclosure of the history leading up to the Merger and used the
vague language described, they had an obligation to provide the stockholders with an
accurate, full, and fair characterization of those historic events,” including the existence
of the bid); Firefighters’ Pension Sys. of Kan. City v. Presidio, Inc., 251 A.3d 251, 261
(Del. Ch. 2021) (“It is reasonably conceivable that the existence of the tip was material
information that should have been disclosed to the stockholders. The Proxy made no
mention of LionTree’s tip to BCP.”); In re Xura, Inc. S’holder Litig., 2018 WL 6498677,
at *13 (Del. Ch. Dec. 10, 2018) (holding that plaintiff adequately pled a claim for breach
of the duty of disclosure where stockholders appeared to lack information about private
communications between CEO and bidders); In re OM Gp., Inc. S’holders Litig., 2016
WL 5929951, at *12 (Del. Ch. Oct. 12, 2016) (“[O]ur Supreme Court recognized that a
partial and incomplete disclosure of arguably immaterial information regarding the
history of negotiations leading to a merger might result in a materially misleading
disclosure if not supplemented with information that would allow the stockholders to
draw the complete picture.”); Alessi v. Beracha, 849 A.2d 939, 946 (Del. Ch. 2004)
(holding that negotiations between buyer’s and target’s CEOs were material when the
parties discussed “significant terms” including “valuation”); see also In re PLX Tech. Inc.
S’holders Litig., 2018 WL 5018535, at *33–34 (Del. Ch. Oct. 16, 2018) (finding after
trial that recommendation statement omitted material information where it failed to
disclose a communication between a director and a potential bidder about the bidder’s
51
There was a time when Delaware law required an agreement in principle on price
and structure before any disclosure obligation arose regarding a transaction involving a
publicly traded company. See Bershad v. Curtiss-Wright Corp., 535 A.2d 840, 847 (Del.
1987). In Bershad, the Delaware Supreme Court held that a board of directors had not
breached its fiduciary duties by failing to disclose “certain casual inquiries” regarding a
potential transaction that the target company flatly rejected and which never led to a sale.
Id. The high court stated: “Efforts by public corporations to arrange mergers are
immaterial under the Rosenblatt v. Getty standard, as a matter of law, until the firms have
agreed on the price and structure of the transaction.” Id.That is no longer the law. One year later, the Supreme Court of the United States
issued its decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which rejected the
price-and-structure rule (also known as the agreement-in-principle test) as contrary to the
materiality standard set forth in TSC Industries. Id. at 232–40. The TSC Industries
standard is the test for materiality that the Delaware Supreme Court adopted in
Rosenblatt. 493 A.2d at 944.
In the immediate aftermath of Basic, it was open to question whether the
agreement-in-principle rule continued to apply to public companies for purposes of
Delaware law. Subsequent developments have made clear that Bershad’s statement no
interest in acquiring the company and the likely timeframe for a bid), aff’d, 211 A.3d 137(Del. 2019) (TABLE).
52
longer stands as a bright-line rule. In Alessi, Chancellor Chandler explained why the
outcome in Bershad made sense on its facts:
In Bershad, the evidence indicated that the defendants informed inquiring
parties that “Dorr-Oliver was not for sale.” In addition, the one inquiring
party that the plaintiff specifically identified “did not have detailed, non-
public financial data on Dorr-Oliver and never seriously considered making
an offer.” The Court held that “since it is undisputed that: (1) Dorr-Oliver
was not for sale, and (2) no offer was ever made for Dorr-Oliver, the
defendants were not obligated to disclose preliminary discussions regarding
an unlikely sale.”
849 A.2d at 945 (cleaned up).
Chancellor Chandler explained at length why the fact-specific ruling in Bershad
could not be read as establishing a “broad and inflexible rule” in which no duty to
disclose arose until there was an agreement as to price and structure. Id. at 946–50. He
observed that the Delaware Supreme Court provided three rationales for ruling in the
defendant’s favor in Bershad:
• “The probability of completing a merger benefiting all shareholders may well
hinge on secrecy during the negotiation process.” Bershad, 535 A.3d at 847 n.5.
• “It would be very difficult for those responsible to determine when disclosures
should be made.” Id.
• “Delaware law does not require disclosure of inherently unreliable or speculative
information which tend to confuse stockholders or inundate them with an overload
of information.”23
23
Chancellor Chandler drew this rationale from Arnold. He observed that
“[a]lthough not found in Bershad, the Delaware Supreme Court stated in Arnold that this
‘principle is consistent with Bershad.’” Alessi, 849 A.2d at 947 n.48 (quoting Arnold, 650
A.2d at 1280).
53
Chancellor Chandler explained that each of these considerations supported a fact-specific
inquiry into whether the information in question was material and needed to be disclosed.
Each consideration could weigh against disclosure in certain circumstances, but not in
others.
• “The first rationale, that secrecy increases shareholder wealth in some cases, is not
a justification for maintaining secrecy in all cases.” Id. at 947.
• “The second rationale, that fiduciaries find non-disclosure of merger negotiations
easier than tough decisions about when to disclose, is insufficient to justify the
omission of material information . . . .” Id. at 948. He explained that materiality
always requires a fact-based judgment in light of all of the circumstances. Any
approach that makes a single fact or occurrence outcome-determinative will
necessarily be over- or underinclusive. Id.
• “The third rationale, shareholder confusion, is the least persuasive.” Id. The
rationale improperly assumed “that investors are nitwits, unable to appreciate—
even when told—that mergers are risk propositions up until the closing.” Id.
Chancellor Chandler concluded that although each of the rationales was a valid concern,
they did not justify a bright-line rule. Id. at 947.
Chancellor Chandler also noted that the Basic decision had rejected the
agreement-in-principle test. The Supreme Court of the United States stated:
We . . . find no valid justification for artificially excluding from the
definition of materiality information concerning merger discussions, which
would otherwise be considered significant to the trading decision of a
reasonable investor, merely because agreement-in-principle as to price and
structure has not yet been reached by the parties or their representatives.
Basic, 485 U.S. at 236. The Basic decision held that “[w]hether merger discussions in any
particular case are material . . . depends on the facts.” Id. at 239. The Supreme Court of
the United States explained instead that whether a contingent event, such as a merger, is
material “will depend at any given time upon a balancing of both the indicated
54
probability that the event will occur and the anticipated magnitude of the event in light of
the totality of the company activity.” Id. at 238 (cleaned up). Chancellor Chandler held
that Delaware law followed the Basic test.24
For public companies, investors have a range of sources of information available,
starting with the stock price itself and extending to analyst reports, news articles, market
coverage, and many other forms of content. For a privately held entity like the Company,
information is tougher to get, and even loose indications of value can be significant. In
this case, the Company had spent the second half of 2020 and the first half of 2021
exploring strategic alternatives and searching for a buyer. In April 2021, management had
told the Board, including representatives of NEA and Core Capital, that the Company had
failed to find a buyer, would be focusing on growing its core business, and that it would
take two to three years before the Company could be sold. Based on that assessment, the
24
There are other Delaware cases which have held that preliminary merger
discussions were not material, but those cases involved preliminary discussions about
deals that never came to fruition, and none of them were rendered at the pleading stage.
See Wayport, 76 A.3d at 321 (post-trial decision involving a fiduciary’s disclosure
obligations when buying stock from another stockholder and finding the existence of an
entity’s proposal was not material because the entity never accepted the company’s
counteroffer, no agreement on price and structure was reached, and the transaction did
not come to fruition); In re MONY Gp. Inc. S’holder Litig., 852 A.2d 9, 29–30 (Del. Ch.
2004) (preliminary injunction decision holding that there was no obligation to disclose an
expression of interest made by an entity other than the ultimate acquirer that “did not
provide a price or structure” and was contingent on the pending deal’s failure); Shamrock
Hldgs., Inc. v. Polaroid Corp., 559 A.2d 257, 261–62, 274–75 (Del. Ch. 1989) (post-trial
decision involving the adoption of an employee stock ownership plan, not a merger, and
holding that there was no obligation to disclose that an entity had “expressed its interest
in a ‘friendly’ meeting” with management because “[i]ts only significance [was] as a
possible forerunner to an acquisition proposal” that ultimately did not materialize).
55
Board and the Company’s stockholders, including NEA and Core Capital, approved the
Recapitalization.
Against that backdrop, the inbound call from Snyk’s CEO to Stella was a
significant development. So was his follow-up email proposing “a proper chat about a
potential deep partnership or (maybe more likely) acquisition,” his representation that
Snyk could “dig in reasonably quickly” to determine the terms of a deal, and his
suggestion that the companies sign up “a fresh MNDA and a refresh mutual demo.” Ex.
5. In contrast to the six-month effort which suggested that no one saw value in the
Company, Snyk’s inbound call showed that someone did. And in contrast to the
assessment that a sale of the Company would not be viable for two to three years, Snyk’s
inbound inquiry suggested the possibility of a near-term liquidity event. Those factors
made the Snyk inquiry particularly significant when the Company was proposing to issue
additional shares of Preferred Stock to insiders and their associates at the same price
agreed to in the Recapitalization.
Under the circumstances, it is reasonably conceivable that the directors’ duty of
disclosure required them to say something to the effect that the Company had received a
recent inbound call from a credible buyer, but that the conversation was preliminary and
there were no assurances that any type of transaction would result. It is reasonably
conceivable that the information would have been important to a stockholder evaluating
whether to consent to the stockholder defendants and other selected investors buying
more Preferred Stock at a price set three months earlier when the Company was running
out of money and thought it had no other prospects. It is reasonably conceivable that the
56
information “would have assumed actual significance in the deliberations” of a
stockholder deciding whether to execute the Written Consent. Rosenblatt, 493 A.2d at
944. Put differently, it is reasonably conceivable that the information “would have been
viewed by the reasonable investor as having significantly altered the ‘total mix’ of
information made available.” Id. At a minimum, additional discovery is warranted before
making a materiality determination as a matter of law, which warrants denying the
motion to dismiss. KCG Hldgs., 2019 WL 2564093, at *10.
The presence of the blank signature blocks for the Non-Consenting Stockholders
supports a pleading-stage inference that some stockholders declined to execute the
Written Consent. There are many possible reasons why that might be so, but at the
pleading stage, one plaintiff-friendly inference is that the stockholders declined because
giving selected Preferred Stockholders the right to buy additional shares at the same price
set three months earlier when the Company was running out of money and thought it had
no other prospects represented too rich a deal for Rich, Rutchik, and their confederates. If
deciding whether to sign off on the Written Consent was a close call in the first place,
then the Company’s receipt of an inbound inquiry, albeit preliminary, would have
assumed even greater significance. It is reasonable to infer that Rich and Rutchik only
secured the necessary votes by giving four of the ten Other Signatories the right to share
in the fruits of the Second Offering.25
25
One wonders if permitting an investor to participate in an undervalued offering
in return for providing the votes needed for the offering to succeed could be viewed as
vote buying. See Crown, 992 A.2d at 390 (discussing third-party vote buying). A transfer
57
It is reasonably conceivable that information about the Snyk inquiry “would have
been viewed by the reasonable investor as having significantly altered the ‘total mix’ of
information made available.” Rosenblatt, 493 A.2d at 944. At a minimum, additional
discovery is warranted before making a materiality determination as a matter of law,
which calls for denying the motion to dismiss. KCG Hldgs., 2019 WL 2564093, at *10.
of value in return for a vote is inferably present. The innovation is that the consideration
for the vote is bundled with the right to participate in an undervalued offering, rather than
through an unbundled side payment. Yet at a superficial level, the same might be said
about any attractive third-party transaction where stockholders vote in favor to receive
the merger consideration. Rather than treating that transaction as a bundled vote, our law
gives the vote powerful cleansing effect. Compare Corwin, 125 A.3d at 312–14 (Del.
2015) (holding that a fully informed stockholder vote on a merger causes the standard of
review to be an irrebuttable version of the business judgment rule) with James D. Cox,
Tomas J. Mondino & Randall S. Thomas, Understanding the (Ir)relevance of
Shareholder Votes on M&A Deals, 69 Duke L.J. 503, 542 (2019) (“Simply stated, the
norm celebrated in Corwin, followed in other contexts in Delaware and well received
outside of Delaware, is that it is permissible to bundle in a single resolution the deal’s
approval as well as a concurrent vote excusing managerial misconduct that occurred or
may have occurred during that transaction.”). An interested transaction where only a
subset of stockholders is permitted to participate might well present a different case than
Corwin cleansing. The idea of giving a preferential right to participate in an attractive
transaction as one side of a quid pro quo resembles the issues involved in IPO spinning,
in which bankers award pre-IPO allocations of stock to individuals who might provide
future business. See In re eBay, Inc. S’holders Litig., 2004 WL 253521, *4–5 (Del. Ch.
Jan. 23, 2004) (holding that ability to participate in IPOs was a corporate opportunity
creating loyalty issues for directors who accepted it); see generally Christine Hurt, Moral
Hazard and the Initial Public Offering, 26 Cardozo L. Rev. 711, 740–44 (2005). The
issue is an intriguing one that warrants further exploration, but this decision is not the
appropriate place for it.
58
3. Is The Disclosure Claim Direct Or Derivative?
A claim for breach of the duty of disclosure can be direct or derivative. To
determine which it is, 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)?” Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del.
2004).
Under the Tooley test, a claim for breach of the duty of disclosure that arises in
connection with a request for stockholder action states a direct claim. Brookfield Asset
Mgmt., Inc. v. Rosson, 261 A.3d 1251, 1263 n.39 (Del. 2021); accord In re J.P. Morgan
Chase & Co. S’holder Litig., 906 A.2d 766, 772 (Del. 2006). The duty of disclosure is
owed to the stockholders themselves, who are injured when the duty is violated. Any
recovery or remedy logically flows to them.
This case presents a twist on that generalization because the plaintiffs are not
suing based on their own right to receive information in connection with a request for
stockholder action, but rather based on a failure to disclose information to the Other
Signatories. In that setting, the only harm the plaintiffs can claim flows to them
indirectly, as a result of the Second Offering. I have previously attempted to explain why
a claim involving the issuance of equity to an insider inflicts both an injury at the entity
level and an injury at the investor level, with the injury primarily felt at the investor level
and the corporate-level injury deriving only from the legal construct that a corporation’s
shares (representing proportionate ownership interests in the firm) are assets of the firm
59
itself.26 But that doctrinal battle has been lost, with the Delaware Supreme Court holding
definitively that claims for equity dilution are only and always derivative. Brookfield, 261
A.3d at 1263.
For purposes of the first prong of Tooley, the answer Brookfield requires is that
only the corporation has suffered an injury. The Other Signatories have suffered an injury
at the investor level because they were deprived of material information, but the suing
stockholders have not suffered that injury. They have only suffered an injury by virtue of
the transaction that the Written Consent approved, which was the dilutive Second
Offering.
The second prong of Tooley generally follows the first prong, because the remedy
typically flows to the injured party. The answer Brookfield requires is that the remedy
26
See In re El Paso Pipeline P’rs, L.P. Deriv. Litig., 132 A.3d 67, 95–118 (Del.
Ch. 2015) (holding that purchase of asset from controller in return for stock inflicted an
injury that was primarily direct but, at a minimum, both derivative and direct, such that
plaintiffs retained standing to pursue a claim after a subsequent controller squeeze-out),
rev’d sub nom. El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248 (Del.
2016) (holding that purchase of asset from controller in return for stock was solely
derivative such that standing to pursue a claim was extinguished by a subsequent
controller squeeze-out merger leaving plaintiff with alternative of challenging the fairness
of the merger); Carsanaro v. Bloodhound Techs., Inc., 65 A.3d 618, 654–61 (Del. Ch.
2013) (holding that interested recapitalization involving dilutive issuance inflicted an
injury that was primarily direct but, at a minimum, both derivative and direct), abrogated
in part by El Paso, 152 A.3d at 1264 (rejecting analysis of dilution claim as having both
direct and derivative components).
60
would flow to the corporation, either by returning some or all of the shares to the
corporate treasurer or through a monetary award to the corporation.27
Because the disclosure claim is derivative, the closing of the Snyk Merger
deprived the plaintiffs of standing to pursue their disclosure claim. See, e.g., Ark. Tchr.
Ret. Sys. v. Countrywide Fin. Corp., 75 A.3d 888, 894 (Del. 2013); Lewis v. Ward, 852
A.2d 896, 904 (Del. 2004); Lewis v. Anderson, 477 A.2d 1040, 1046 (Del. 1984). Count
III is therefore dismissed.
D. Counts IV and V: Claims Against The Rich Entities And The Rutchik Trust
Based On The Second Offering And The Option Grants
In Counts IV and V of the complaint, the plaintiffs assert claims against the Rich
Entities and the Rutchik Trust based on the Second Offering and the Option Grants. In
Count IV, the plaintiffs contend that the Rich Entities were the Company’s controlling
stockholders, owed the same duty of disclosure in connection with the Second Offering
and the Option Grants as the directors, and breached its duty as the directors did. In
27
The analysis is not so simple, because a court of equity can award a stockholder-
level remedy for a derivative claim. See Goldstein v. Denner, 2022 WL 1797224, at *15–
20 (Del. Ch. June 2, 2022) (collecting authorities); compare Deane v. Maginn, 2022 WL
16557974, at *29 (Del. Ch. Nov. 1, 2022) (awarding investor-level recovery for
derivative claim), with Bamford v. Penfold, L.P., 2022 WL 2278867, at *54–56 (Del. Ch.
June 24, 2022) (considering but rejecting request for stockholder-level remedy for
derivative claim). That type of remedial calculus comes at the end of the case, while the
Tooley assessment generally comes at the beginning. As a practical matter, the court’s
remedial flexibility means that the second prong of Tooley does not play much of a role
in the analysis. The characterization of the injury in the first prong dominates the
outcome.
61
Count V, the plaintiffs contend that the Rutchik Trust aided and abetted the directors and
the Rich Entities in breaching their fiduciary duty of disclosure.
Counts IV and V fail to state a disclosure claim based on the Option Grants for the
same reasons as Count III. Whether Counts IV and V state claims based on the Second
Offering presents a relatively easy call for Count V and a more difficult call for Count
IV. In the interest of brevity, this decision will not analyze those claims because each is
derivative for the same reasons that Count III is derivative. The closing of the Snyk
Merger deprived the plaintiffs of standing to pursue Counts IV and V, which are
therefore dismissed.
E. Count VI: The Claim That The Director Defendants Breached Their
Fiduciary Duties By Approving The Snyk Merger
In Count VI of the complaint, NEA and Core Capital challenge the Snyk Merger
on the theory that (i) it was an interested transaction that conferred unique benefits on the
defendants by extinguishing the plaintiffs’ standing to maintain derivative claims and (ii)
the merger consideration did not take into account the value of the derivative claims. In
advancing this theory, the plaintiffs allege that the Second Offering and Option Grants
were interested transactions in their own right and that the defendants would not have
been able to show that those transactions were entirely fair (the “Interested Transaction
Claims”). Those claims are distinct from the claim for breach of the duty of disclosure in
connection with the Second Offering (the “Disclosure Claim”), discussed above, which
the plaintiffs sought to maintain as a direct claim, but which this decision has held to be
62
derivative. For purposes of the challenge to the Snyk Merger, both the Interested
Transaction Claims and the Disclosure Claim are in play.
Evaluating whether the plaintiffs have stated a claim against the Snyk Merger
involves a two-step process. First, the plaintiffs must show that they have standing to
challenge the Snyk Merger. Second, the plaintiffs must have stated a claim against the
defendants on which relief can be granted.
1. The Plaintiffs’ Standing To Challenge The Snyk Merger
The Delaware Supreme Court has endorsed a pleading-stage framework that this
court used in the Primedia decision to evaluate whether a plaintiff had standing to
challenge a merger based on the extinguishment of derivative standing. Morris v. Spectra
Energy P’rs (DE) GP, LP, 246 A.3d 121, 136 (Del. 2021) (“When the court is faced with
a post-merger claim challenging the fairness of a merger based on the defendant’s failure
to secure value for derivative claims, we think that the Primedia framework provides a
reasonable basis to conduct a pleadings-based analysis to evaluate standing on a motion
to dismiss.”). The Primedia decision described the framework as follows:
A plaintiff claiming standing to challenge a merger directly under Parnes
because of a board’s alleged failure to obtain value for an underlying
derivative claim must meet a three part test. First, the plaintiff must plead
an underlying derivative claim that has survived a motion to dismiss or
otherwise could state a claim on which relief could be granted. Second, the
value of the derivative claim must be material in the context of the merger.
Third, the complaint challenging the merger must support a pleadings-stage
inference that the acquirer would not assert the underlying derivative claim
and did not provide value for it.
In re Primedia, Inc. S’holders Litig., 67 A.3d 455, 477 (Del. Ch. 2013). In this case, the
plaintiffs can meet all of the Primedia requirements.
63
a. Viable Derivative Claims
The first Primedia element is met because the plaintiffs have pled derivative
claims that would survive a Rule 12(b)(6) motion to dismiss. This decision has held that
the Disclosure Claim passes muster under Rule 12(b)(6). The Interested Transaction
Claims do too.
i. The Governing Law
The plaintiffs contend that Rich, Rutchik, and Stella breached their fiduciary
duties when approving the Second Offering and the Option Grants. To determine whether
directors have complied with their fiduciary duties, Delaware courts evaluate their actions
through the lens of a standard of review. “Delaware has three tiers of review for
evaluating director decision-making: the business judgment rule, enhanced scrutiny, and
entire fairness.” Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457 (Del. Ch. 2011).
Delaware’s default standard of review is the business judgment rule. That standard
of review presumes that “in making a business decision the directors of a corporation
acted on an informed basis, in good faith and in the honest belief that the action taken
was in the best interests of the company.” 28 Unless a plaintiff rebuts one of the elements
28
Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). In Brehm v. Eisner, the
Delaware Supreme Court overruled seven decisions, including Aronson, to the extent
those precedents reviewed a Rule 23.1 decision by the Court of Chancery under an abuse
of discretion standard or otherwise suggested deferential appellate review. See 746 A.2d
244, 253 n.13 (Del. 2000) (overruling in part on this issue Scattered Corp. v. Chi. Stock
Exch., 701 A.2d 70, 72–73 (Del. 1997); Grimes v. Donald, 673 A.2d 1207, 1217 n.15
(Del. 1996); Heineman v. Datapoint Corp., 611 A.2d 950, 952 (Del. 1992); Levine v.
Smith, 591 A.2d 194, 207 (Del. 1991); Grobow v. Perot, 539 A.2d 180, 186 (Del. 1988);
Pogostin v. Rice, 480 A.2d 619, 624–25 (Del. 1984); and Aronson, 473 A.2d at 814). The
64
of the rule, “the court merely looks to see whether the business decision made was
rational in the sense of being one logical approach to advancing the corporation’s
objectives.” In re Dollar Thrifty S’holder Litig., 14 A.3d 573, 598 (Del. Ch. 2010). Only
when a decision lacks any rationally conceivable basis will a court infer bad faith and a
breach of duty.29 The business judgment rule thus provides “something as close to non-
review as our law contemplates.” Kallick v. Sandridge Energy, Inc., 68 A.3d 242, 257
Brehm Court held that going forward, appellate review of a Rule 23.1 determination
would be de novo and plenary. 746 A.2d at 253. The seven partially overruled precedents
otherwise remain good law. This decision does not rely on any of them for the standard
of appellate review. Having described Brehm’s relationship to these cases, this decision
omits the cases’ cumbersome subsequent history, because stating that they were
overruled by Brehm creates the misimpression that Brehm rejected a series of
foundational Delaware decisions.
More recently, the Delaware Supreme Court overruled Aronson and Rales v.
Blasband, 634 A.2d 927 (Del. 1993), to the extent that they set out alternative tests for
demand futility. United Food & Com. Workers Union & Participating Food Indus.
Empls. Tri-State Pension Fund v. Zuckerberg, 262 A.3d 1034, 1059 (Del. 2021). The
high court adopted a single, unified test for demand futility. Although the Zuckerberg test
displaced the prior tests, cases properly applying Aronson and Rales remain good law. Id.This decision therefore does not identify any precedents, including Aronson and Rales, as
having been overruled by Zuckerberg.
29
See Brehm, 746 A.2d at 264 (“Irrationality is the outer limit of the business
judgment rule. Irrationality may be the functional equivalent of the waste test or it may
tend to show that the decision is not made in good faith, which is a key ingredient of the
business judgment rule.” (footnote omitted)); In re J.P. Stevens & Co., Inc. S’holders
Litig., 542 A.2d 770, 780–81 (Del. Ch. 1988) (Allen, C.) (“A court may, however, review
the substance of a business decision made by an apparently well motivated board for the
limited purpose of assessing whether that decision is so far beyond the bounds of
reasonable judgment that it seems essentially inexplicable on any ground other than bad
faith.” (internal citation omitted)).
65
(Del. Ch. 2013). This standard of review “reflects and promotes the role of the board of
directors as the proper body to manage the business and affairs of the corporation.” In re
Trados Inc. S’holder Litig. (Trados I), 2009 WL 2225958, at *6 (Del. Ch. July 24, 2009);
see generally Stephen M. Bainbridge, The Business Judgment Rule as Abstention
Doctrine, 57 Vand. L. Rev. 83 (2004).
Delaware’s most onerous standard of review is the entire fairness test. When entire
fairness governs, the defendants must establish “to the court’s satisfaction that the
transaction was the product of both fair dealing and fair price.” Cinerama, Inc. v.
Technicolor, Inc., 663 A.2d 1156, 1163 (Del. 1995) (citation omitted). “Not even an
honest belief that the transaction was entirely fair will be sufficient to establish entire
fairness. Rather, the transaction itself must be objectively fair, independent of the board’s
beliefs.” Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1145 (Del. Ch. 2006).
In between lies enhanced scrutiny, which “is Delaware’s intermediate standard of
review.” In re Trados Inc. S’holder Litig. (Trados II), 73 A.3d 17, 43 (Del. Ch. 2013). It
applies to “specific, recurring, and readily identifiable situations involving potential
conflicts of interest where the realities of the decisionmaking context can subtly
undermine the decisions of even independent and disinterested directors.”30 Inherent in
30
Id.; accord Reis, 28 A.3d at 457–59; see Paramount Commc’ns, Inc. v. QVC
Network, Inc., 637 A.2d 34, 42 (Del. 1994) (“[T]here are rare situations which mandate
that a court take a more direct and active role in overseeing the decisions made and
actions taken by directors. In these situations, a court subjects the directors’ conduct to
enhanced scrutiny to ensure that it is reasonable.”); Dollar Thrifty, 14 A.3d at 598 (“In a
situation where heightened scrutiny applies, the predicate question of what the board’s
true motivation was comes into play. The court must take a nuanced and realistic look at
66
these situations are subtle structural and situational conflicts that do not rise to a level
sufficient to trigger entire fairness review, but also do not comfortably permit expansive
judicial deference.31 Framed generally, enhanced scrutiny requires that the defendant
fiduciaries “bear the burden of persuasion to show that their motivations were proper and
not selfish” and that “their actions were reasonable in relation to their legitimate
objective.” Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786, 810 (Del. Ch. 2007). The
Second Offering and the Option Grants do not fit any of the established situations in
which enhanced scrutiny applies, rendering that standard inapplicable.
Analysis starts with the default standard of the business judgment rule. The
question is whether the plaintiffs have alleged facts sufficient to rebut one of the
presumptions of the business judgment rule, thereby creating a pleading-stage inference
that the directors would bear the burden of proving that their actions were entirely fair. If
the possibility that personal interests short of pure self-dealing have influenced the board
to block a bid or to steer a deal to one bidder rather than another.”).
31
In re Rural Metro Corp. S’holders Litig., 88 A.3d 54, 82 (Del. Ch. 2014), aff’d
sub nom. RBC Cap. Mkts., LLC v. Jervis, 129 A.3d 816 (Del. 2015); accord Huff Energy
Fund, L.P. v. Gershen, 2016 WL 5462958, at *13 (Del. Ch. Sept. 29, 2016); see Dollar
Thrifty, 14 A.3d at 597 (“Avoiding a crude bifurcation of the world into two starkly
divergent categories—business judgment rule review reflecting a policy of maximal
deference to disinterested board decisionmaking and entire fairness review reflecting a
policy of extreme skepticism toward self-dealing decisions—the Delaware Supreme
Court’s Unocal and Revlon decisions adopted a middle ground.”); Golden Cycle, LLC v.
Allan, 1998 WL 892631, at *11 (Del. Ch. Dec. 10, 1998) (locating the Unocal and
Revlon enhanced scrutiny standard between the business judgment rule and the entire
fairness test).
67
the plaintiffs have alleged facts at the pleading stage that support an inference of
unfairness, then the court must credit those allegations. The defendants cannot introduce
evidence at the pleading stage, nor can a court weigh competing evidence. Therefore, a
plaintiff who has alleged facts sufficient to rebut the business judgment rule and support
an inference of unfairness will survive a Rule 12(b)(6) motion.
To change the pleading-stage standard of review from the business judgment rule
to entire fairness, the complaint must allege facts supporting a reasonable inference that
there were not enough sufficiently informed, disinterested individuals who acted in good
faith when taking the challenged actions to comprise a board majority. See Aronson, 473
A.2d at 812. Consequently, to determine whether to intensify the standard of review from
business judgment to entire fairness, a court counts heads. Frederick Hsu Living Tr. v.
ODN Hldg. Corp., 2017 WL 1437308, at *26 (Del. Ch. Apr. 14, 2017). If a director-by-
director analysis leaves insufficient directors to make up a board majority, then the court
will review the decision for entire fairness. Id.At the pleading stage, a plaintiff can prevent a director from qualifying as part of
the requisite board majority by alleging that the director received “a personal financial
benefit from a transaction that is not equally shared by the stockholders.”32 A plaintiff
32
Rales, 634 A.2d at 936 (citations omitted); accord Cede & Co. v. Technicolor,
Inc., 634 A.2d 345, 362 (Del. 1993) (“Classic examples of director self-interest in a
business transaction involve either a director appearing on both sides of a transaction or a
director receiving a personal benefit from a transaction not received by the shareholders
generally.”); Pogostin, 480 A.2d at 624 (“Directorial interest exists whenever . . . a
director either has received, or is entitled to receive, a personal financial benefit from the
challenged transaction which is not equally shared by the stockholders.”).
68
also can prevent a director from qualifying as part of the requisite board majority by
alleging that the director was sufficiently loyal to, beholden to, or otherwise influenced
by an interested party to undermine the director’s ability to judge the matter on its
merits.33 There are other means as well, but those two are sufficient for this case.
ii. The Governing Law And The Second Offering
The Second Offering was an interested transaction to which the entire fairness test
would apply. At the time of the Second Offering, the Board comprised Rich, Rutchik, and
Stella. None qualify as disinterested and independent.
For a director to be disinterested, the director “can neither appear on both sides of
a transaction nor expect to derive any personal financial benefit from it in the sense of
self-dealing, as opposed to a benefit which devolves upon the corporation or all
stockholders generally.” Aronson, 473 A.2d at 812. The benefit that the director receives
must be sufficiently material to rebut the presumption of loyalty. Technicolor, 634 A.2d
33Aronson, 473 A.2d at 815 (stating that one way to allege successfully that an
individual director is under the control of another is by pleading “such facts as would
demonstrate that through personal or other relationships the directors are beholden to the
controlling person”); Friedman v. Beningson, 1995 WL 716762, at *4 (Del. Ch. Dec. 4,
1995) (Allen, C.) (“The requirement that directors exercise independent judgment,
(insofar as it is a distinct prerequisite to business judgment review from a requirement
that directors exercise financially disinterested judgment[)], directs a court to an inquiry
into all of the circumstances that are alleged to have inappropriately affected the exercise
of board power. This inquiry may include the subject whether some or all directors are
‘beholden’ to or under the control, domination or strong influence of a party with a
material financial interest in the transaction under attack, which interest is adverse to that
of the corporation.”). Classic examples involve familial relationships, such as a parent’s
love for and loyalty to a child. See, e.g., Harbor Fin. P’rs v. Huizenga, 751 A.2d 879,
889 (Del. Ch. 1999).
69
at 363. “Directorial interest also exists where a corporate decision will have a materially
detrimental impact on a director, but not on the corporation and the stockholders.” Rales,
634 A.2d at 936.
Rich and Rutchik both approved the Second Offering and participated in it. They
stood on both sides of the transaction and benefitted from it. The opportunity to buy
undervalued Preferred Stock at the same price set in the Recapitalization was not shared
equally with other stockholders. Perhaps they bought shares of Preferred Stock in the
Second Offering as a favor or on a lark, but given that they pursued and participated in
the Second Offering, it is reasonable to infer at the pleading stage that the benefit they
secured was material to them. Rich and Rutchik therefore cannot qualify as disinterested
for purposes of the Second Offering.
Stella was the CEO. He reported to the Board majority consisting of Rich and
Rutchik, and Rich controlled the Company through the Rich Entities. Under the great
weight of Delaware precedent, senior corporate officers generally lack independence for
purposes of evaluating matters that implicate the interests of either a controller or a
conflicted board majority.34 Stella did not participate in the Second Offering and
34
Many of the cases standing for this proposition involve the issue of
disqualification for purposes of demand futility under Rule 23.1 rather than an inference
of a lack of independence under Rule 12(b)(6). Rule 23.1 requires a higher pleading
standard, making those precedents all the more persuasive for purposes of analysis under
Rule 12(b)(6). E.g., id. at 937 (holding that President and CEO of corporation could not
impartially consider a litigation demand which, if granted, would have resulted in a suit
adverse to significant stockholders); In re The Student Loan Corp. Deriv. Litig., 2002 WL
75479, at *3 (Del. Ch. Jan. 8, 2002) (“In the case of [the CEO], to accept such a
[litigation] demand would require him to decide to have Student Loan sue Citigroup, an
70
therefore was not interested in that transaction, but he was not independent of Rich and
Rutchik for purposes of the decision to approve it.
Because there were no disinterested and independent directors to approve the
Second Offering, the entire fairness standard applies. The plaintiffs have pled facts
supporting an inference of unfairness. When approving the Second Offering, Rich,
Rutchik, and Stella allowed the participating stockholders, including Rich and Rutchik
and their affiliates, to acquire Preferred Stock at the same price and on the same terms
that Rich had extracted three months before, in April 2021, when the Company was
running out of money and had spent six months exploring a potential sale in an effort that
failed to generate any interest. When Rich negotiated that transaction, he was the only
act that would displease a majority stockholder in a position to displace him from his
lucrative CEO position.”); Mizel v. Connolly, 1999 WL 550369, at *3 (Del. Ch. July 22,
1999) (observing that President and CEO of corporation whose position constituted his
principal employment was not independent for demand-futility purposes where
underlying transaction was between corporation and its controller); Steiner v. Meyerson,
1995 WL 441999, at *10 (Del. Ch. July 19, 1995) (Allen, C.) (“The facts alleged appear
to raise a reasonable doubt that Wipff, as president, chief operating officer, and chief
financial officer, would be unaffected by [the CEO and significant stockholder’s] interest
in the transactions that the plaintiff attacks.”); see Bakerman, 2006 WL 3927242, at *9
(holding that reasonable doubt existed as to ability of insider managers of LLC to address
a litigation demand focusing on the entity’s controllers); see also MCG Cap. Corp. v.
Maginn, 2010 WL 1782271, at *20 (Del. Ch. May 5, 2010) (“There may be a reasonable
doubt about a director’s independence if his or her continued employment and
compensation can be affected by the directors who received the challenged benefit.”); In
re Cooper Cos., Inc. S’holders Deriv. Litig., 2000 WL 1664167, at *6 (Del. Ch. Oct. 31,
2000) (finding reasonable doubt existed as to ability of two directors, one of whom was
also CFO and Treasurer and the other who was also Vice President and General Counsel,
to consider litigation demand addressing actions by other directors).
71
game in town, and he held all the cards. He was able to secure a deal that valued the
Company’s existing equity at only $10 million, he forced all of the existing preferred
stockholders to convert their shares into common stock and give up all of their special
rights, and he extracted Preferred Stock with powerful terms, including a 2x liquidation
preference. After the Recapitalization injected $8 million into the Company, the situation
was different. The Company had enough cash to operate for a significant period.
Moreover, the Company had received the inbound expression of interest from Snyk.
Although preliminary, that expression of interest changed the environment from one in
which no one had shown any interest that would validate the Company’s worth to one in
which a third party had expressed interest in an acquisition. It is reasonable to infer that
using the distressed-entity pricing from April for a non-distressed transaction in July was
not entirely fair.
The defendants argue in response that just before the Recapitalization closed, Rich
proposed increasing the investment round from $8 million to $10 million, but that the
Board refused. They claim that after Rich joined the Board and evaluated the Company,
he determined that the Company really did need more than $8 million. They say that Rich
did not pursue the Second Offering selfishly, but rather because the Company needed the
money.
The defendants’ account departs from the allegations of the complaint, and at the
pleading stage, the court must credit the plaintiffs’ account. In any event, the defendants’
story does not explain why it was fair to price the Second Offering on the same terms as
the Recapitalization. Even assuming that the Company needed a longer runway, it was
72
not in the same position as it was in April 2021 when Rich negotiated the terms of the
Recapitalization. One of the sayings in the start-up industry is that it’s better to raise
capital when its available than when you need it, but that does not mean you should pay
for the capital that is available as if you need it.
The defendants also argue that they did not know and could not have known in
July 2021 that the Snyk inquiry would blossom into the Snyk Merger. The level of
confidence that the Board had in the Snyk inquiry is a contested fact, but accepting that
nothing in the world is certain, that does not mean that the Board could price the Second
Offering without giving any credence to the Snyk inquiry. It is reasonable to infer that the
Snyk inquiry had importance as a signal of validation for the Company. Just as the failure
of the six-month sale process to generate any nibbles suggested that potential acquirers
did not see any value in the Company, the Snyk inquiry suggested the opposite. And it
suggested that the pricing used for the Recapitalization was outdated.
Another common saying in the investment world is that you make your money
when you buy, not when you sell. To benefit from the Second Offering, Rich, Rutchik,
and their associates did not need to believe that the Snyk inquiry would develop into a
sale. They only had to believe that the Company was worth more in July 2021 than the
valuation that Rich extracted in April. It is reasonable to infer that Rich, Rutchik, and
their associates held that belief and that they bought what they thought were undervalued
shares of Preferred Stock in the Second Offering, expecting that an undervalued purchase
price would enable them to realize a bigger gain whenever the Company was sold,
whether to Snyk or to someone else.
73
It is reasonable to infer that the Second Offering would be subject to the entire
fairness test and that the transaction was not entirely fair. It is therefore reasonable to
infer that a derivative claim challenging the Second Offering would survive a motion to
dismiss.
iii. The Governing Law And The Option Grants
As described in the Factual Background, the Option Grants came in two flavors:
the Interested Grants to Rich, Rutchik, and Stella, plus the Disinterested Grants to
employees and advisors. The complaint provides no basis to infer that the Board was not
disinterested and independent as to the Disinterested Grants, so the business judgment
rule applies. A derivative claim challenging the Disinterested Grants would not survive a
motion to dismiss.
The opposite is true for the Interested Grants. When directors determine their own
compensation, they engage in self-interested conduct. In re Invs. Bancorp, Inc. S’holder
Litig., 177 A.3d 1208, 1217 (Del. 2017). Absent some cleansing mechanism, the decision
will “lie outside the business judgment rule’s presumptive protection, so that, where
properly challenged, the receipt of self-determined benefits is subject to an affirmative
showing that the compensation arrangements are fair to the corporation.” Telxon Corp. v.
Meyerson, 802 A.2d 257, 265 (Del. 2002).
The Interested Grants covered 3,084,203 shares and represented 51% of the total
Option Grants. Rich, Rutchik, and Stella thus granted themselves more options than they
awarded to thirty-one different employees and two advisors.
74
Stella’s grant of 2,050,227 options represented one third of the Option Grants.
While sizable, Stella was the Company’s CEO, suggesting that there could be some basis
to find that his grant was entirely fair. The court cannot make that determination at the
pleading stage, but giving the CEO a lot of options does comport with industry practice.
Rutchik’s grant of 886,265 options seems particularly large. It comprised 15% of
the Option Grants as a whole and was larger by a considerable margin than any grant
other than Stella’s. Perhaps there is a reason why an investor and board member received
so large a grant. At the pleading stage, it is reasonable to indulge the plaintiff-friendly
inference that it was partially compensation for board service and partially a quid pro quo
for being helpful to Rich.
Rich received options on 147,711 shares, the same as the sixth-highest employee
after Stella. Perhaps that was a fair amount of compensation for a director. At the
pleading stage, it is reasonable to indulge the plaintiff-friendly inference that it was a
self-interested giveaway.
In addition to the size of the Interested Grants, there is also reason to question their
timing. They were made shortly after the Snyk inquiry, yet the exercise price was set at
$0.10 per share. Recall that in the Recapitalization, the agreed-upon value of Company’s
pre-transaction equity was $10 million. After all of the Preferred Stock was converted
into common stock, the Company’s pre-transaction equity consisted of 8,921,712
common shares. The Recapitalization itself thus implicitly valued the common stock at
$1.12 per share, and that was at a time when the Company needed new capital and did
not believe it had any meaningful prospects for a sale. Three months later, after the
75
Second Offering, the Company had $10 million on its balance sheet and had received an
expression of interest from Snyk. It is reasonable to infer that in July 2021, the
Company’s value exceeded $1.12 per common share. Yet the directors set the exercise
price for the options at $0.10 per share.
A board may see fit to grant in-the-money options to employees or advisors, and
assuming that decision does not violate the terms of a governing plan document, the
board’s decision will be protected by the business judgment rule. Desimone v. Barrows,
924 A.2d 908, 934 (Del. Ch. 2007). When directors make sizable grants of in-the-money
options to themselves, the directors must establish the fairness of their actions. Using the
$1.12 per share figure as a plug number, the directors granted themselves options that
were in the money to the tune of $2,091,231, setting aside any increase in value above
$1.12 from the Company’s improved position relative to April 2021, and setting aside
any additional contingent value calculated by another method, such as the Black-Scholes
formula.35
A derivative challenge to the Interested Grants would survive a motion to dismiss
under Rule 12(b)(6).
b. A Material Amount In The Context Of The Snyk Merger
The second Primedia element is met because it is reasonably conceivable that the
value of the Interested Transaction Claims was material in the context of the Snyk
35
Because the Company is privately held, the Black-Sholes formula does not
apply directly. The point is that the options had option value, i.e., contingent value over
and above their intrinsic, in-the-money value.
76
Merger. There is no bright-line figure for materiality. Goldstein, 2022 WL 1797224, at
*11. One place to look for pleading-stage guidance is the 5% rule of thumb that laypeople
use as a rough guide. Id. Another source is the magnitude of the baskets that parties agree
to for purposes of deal-related indemnification, because the size of those limits indicates
the magnitude of loss that a party is willing to swallow before it can assert a claim to
recover. The second Primedia element asks the same basic question: How much loss
must sell-side stockholders swallow before gaining standing to assert a claim to recover
that value. Studies of basket amounts suggest a rule of thumb of 0.5% to 1%. Harris v.
Harris, 2023 WL 115541, at *12 & n.6 (Del. Ch. Jan. 6, 2023). A third place to look is
the magnitude of the cash settlement payments that the Delaware Court of Chancery has
approved to resolve litigation challenging transactions, measured as a percentage of the
transaction value. The fact that the court has approved a settlement as fair and reasonable
indicates that the amount received was material to the stockholder class that claimed to be
injured in the transaction. For example, when approving a settlement of litigation
challenging Kinder Morgan’s acquisition of El Paso Corporation, then-Chancellor Strine
described a cash settlement payment equal to approximately 0.5% of the merger
consideration as “a very large monetary settlement,” “a very substantial achievement for
77
the class,” “real money,” and a “very good settlement for the class.”36 Other settlements
involving third-party deals suggest that amounts of 1-2% are material.37
Based on the complaint and the documents it incorporates by reference, it is
possible to make some rough, pleading-stage estimates of the value of the Interested
Transaction Claims. Working backwards from the complaint’s allegations that each share
of Preferred Stock received $4.44 in the deal and each share of common stock received
$3.22, it is possible to estimate total deal consideration at $123,324,378.68 (without the
proceeds from option exercise).38
36
In re El Paso Corp. S’holder Litig., C.A. No. 6959-CS, at 36–37, 39–40 (Del.
Ch. Dec. 3, 2012) (TRANSCRIPT).
37
See Morrison v. Berry, C.A. No. 12808-VCG, at 15 (Del. Ch. July 7, 2021)
(TRANSCRIPT) (approving as reasonable a settlement payment equal to 2% premium to
deal price; “[T]he idea that the settlement was anything short of appropriate I think would
be fatuous, because this, I think, is an excellent result for the stockholder class . . . .”); In
re TIBCO Software, Inc. S’holders Litig., C.A. No. 10319-CB, at 44 (Del. Ch. Sept. 7,
2016) (TRANSCRIPT) (approving as reasonable a settlement payment equal to 1.2%
premium to deal price; “[T]he settlement is an excellent outcome for the shareholders, in
my opinion.”); see also Chester Cnty. Empls.’ Ret. Fund v. KCG Hldgs., Inc., C.A. No.
2017-0421-KSJM, at 32 (Mar. 31, 2020) (TRANSCRIPT) (approving as reasonable a
settlement payment equal to 2.3% of transaction consideration to resolve challenge to an
arm’s-length deal); Appel v. Berkman, C.A. No. 12844-VCF, at 45–46 (Del. Ch. Feb. 20,
2020) (TRANSCRIPT) (approving as reasonable and deeming “significant” a settlement
payment equal to 1.1% of transaction consideration to resolve challenge to an arm’s-
length deal); Chen v. Howard-Anderson, C.A. 5878-VCL, at 40 (Del. Ch. Aug. 26, 2016)
(TRANSCRIPT) (approving as reasonable a settlement payment equal to 1.7% of
transaction consideration to resolve challenge to an arm’s-length deal).
38
8,921,712 shares of common stock plus 6,029,555 additional shares from option
exercise = 14,951,267 shares of common.
14,951,267 shares of common * $3.22 per share = $48,143,079.74.
78
The Company’s simple capital structure facilitates the calculations.39 Using the
waterfall of a liquidation preference for the Preferred Shares equal to two times the
purchase price of $0.61 per share, followed by a distribution of the remaining proceeds
pro rata to all holders of common and Preferred Stock, it is possible to estimate that the
Second Offering alone resulted in Rich, Rutchik, and Stella receiving $5 million more
than they would have received if the Second Offering had not taken place. That amount
represents 4% of the transaction proceeds, which is inferably a material percentage of the
transaction consideration. The following table shows the more detailed calculations.40
17,068,751 shares of Preferred Stock * $4.44 = $75,785,254.44.
Total distributions include $602,955.50 from option exercise at $0.10 per share.
$48,143,079.74 + $75,785,254.44 - $602,955.50 = $123,325,378.68.
39
For Rutchik’s share, the calculations only consider the Rutchik Trust’s
ownership of Preferred Stock, the additional shares that Rutchik purchased in the Second
Offering, and the options that Rutchik received in the Interested Grants. Rutchik appears
to control Nodozac, and the court included Nodozac’s holdings of Preferred Stock when
calculating the voting power Rutchik controlled. The plaintiffs, however, have not named
Nodozac as a defendant, and they do not appear to take issue with the amounts Rutchik
received through Nodozac, so the damages calculation excludes Nodozac’s shares when
determining Rutchik’s take.
40
As the more detailed calculations show, excluding the Second Offering affects
the defendants differently. Rich gained substantially from the Second Offering because
he acquired the bulk of the additional shares of Preferred Stock, so invalidating the
Second Offering causes him to lose $5.1 million. Rutchik held fewer shares of Preferred
Stock and participated more through his share of the Interested Grants, so he loses
$816,188. Stella only participated through common stock, so he gains by $926,026. The
calculations would differ if Rutchik’s holdings of Preferred Stock through Nodozac were
included.
79
Actual Transaction Without Second Issuance
Estimated Transaction Proceeds Excluding Option Exercise 123,325,378.68 123,325,378.68
Proceeds from Option Exercise 602,955.50 602,955.50
Total Proceeds 123,928,334.18 123,928,334.18
Preferred Stock Liquidation Preference 20,823,876.22 20,823,876.22
Rich Entities' Liquidation Preference 13,788,508.32 10,384,603.40
Rutchik Trust's Liquidation Preference 1,051,204.46 650,745.56
Net proceeds for participating holders 103,104,457.96 103,104,457.96
Fully diluted shares 32,020,018.00 28,081,077.00
Per Share Consideration 3.22 3.67
Rich Entities' Share of Per Share Consideration From Preferred 36,392,620.32 31,253,147.91
Rich Entities' Share of Per Share Consideration From Common 475,629.42 542,346.10
Rutchik Trust's Share of Per Share Consideration From Preferred 2,774,490.46 1,958,461.62
Rutchik Trust's Share of Per Share Consideration From Common 2,853,773.30 3,254,072.93
Rich Entities' Total Proceeds 57,692,125.96 52,619,370.23
Rutchik Trust's Total Proceeds 6,679,468.22 5,863,280.11
Stella's Share From Common 6,601,730.94 7,527,757.70
Defendants' Total Proceeds 70,973,325.12 66,010,408.04
Other Stockholders' Total Proceeds 52,955,009.06 57,917,926.14
Other Stockholders' Damages Relative To Actual Transaction 4,962,917.08
Damages As Percentage of Deal Consideration 4.00%
Rich Delta -5,072,755.73
Rutchik Delta -816,188.11
Stella Delta 926,026.76
Based on the court’s estimates, the Interested Grants alone resulted in Rich,
Rutchik, and Stella receiving $5.4 million more than they would have received if the
Interested Grants had not taken place. That amount represents 4.4% of the transaction
proceeds, which is again a material percentage of the transaction consideration. The
following table shows the more detailed calculations.41
41
As the more detailed calculations show, excluding the Interested Grants affects
the defendants differently. Rich received relatively few options relative to Stella and
Rutchik, so cancelling the Interested Grants causes him to gain more from his Preferred
Stock than he loses from his cancelled options, resulting in his share of the proceeds
increasing by $3.4 million. Rutchik received $3.1 million from his grant, so although
excluding the Interested Grants causes him to gain some from his Preferred Stock, he is a
net loser to the tune of $2.6 million. Stella takes the biggest hit because he only received
a share of the merger consideration through the Interested Grants, so he loses $6.6
80
Actual Transaction Without Interested Grants
Estimated Transaction Proceeds Excluding Option Exercise 123,325,378.68 123,325,378.68
Proceeds from Option Exercise 602,955.50 294,535.20
Total Proceeds 123,928,334.18 123,619,913.88
Preferred Stock Liquidation Preference 20,823,876.22 20,823,876.22
Rich Entities' Liquidation Preference 13,788,508.32 13,788,508.32
Rutchik Trust's Liquidation Preference 1,051,204.46 1,051,204.46
Net proceeds for participating holders 103,104,457.96 102,796,037.66
Fully diluted shares 32,020,018.00 28,935,815.00
Per Share Consideration 3.22 3.55
Rich Entities' Share of Per Share Consideration From Preferred 36,392,620.32 40,151,161.26
Rich Entities' Share of Per Share Consideration From Common 475,629.42 0.00
Rutchik Trust's Share of Per Share Consideration From Preferred 2,774,490.46 3,061,033.06
Rutchik Trust's Share of Per Share Consideration From Common 2,853,773.30 0.00
Rich Entities' Total Proceeds 57,692,125.96 60,975,037.48
Rutchik Trust's Total Proceeds 6,679,468.22 4,112,237.52
Stella's Share From Common 6,601,730.94 0.00
Defendants' Total Proceeds 70,973,325.12 65,087,275.00
Other Stockholders' Total Proceeds 52,955,009.06 58,532,638.88
Other Stockholders' Damages Relative To Actual Transaction 5,577,629.82
Damages As Percentage of Deal Consideration 4.51%
Rich Delta 3,282,911.52
Rutchik Delta -2,567,230.70
Stella Delta -6,601,730.94
Based on the court’s estimates, the combination of the Second Offering and the
Interested Grants resulted in Rich, Rutchik, and Stella receiving $11.9 million more than
they would have received if the Interested Grants had not taken place. That amount
represents 9.7% of the transaction proceeds, which is again a material percentage of the
transaction consideration. The following table shows the more detailed calculations.42
million. The calculations again would differ if Rutchik’s holdings of Preferred Stock
through Nodozac were included.
42
Once again, the more detailed calculations show that excluding both the Second
Offering and the Interested Grants affects the defendants differently. With fewer shares
of Preferred Stock taking a liquidation preference, more funds fall to the pro rata
81
Actual Transaction Without Both
Estimated Transaction Proceeds Excluding Option Exercise 123,325,378.68 123,325,378.68
Proceeds from Option Exercise 602,955.50 294,535.20
Total Proceeds 123,928,334.18 123,619,913.88
Preferred Stock Liquidation Preference 20,823,876.22 20,823,876.22
Rich Entities' Liquidation Preference 13,788,508.32 10,384,603.40
Rutchik Trust's Liquidation Preference 1,051,204.46 650,745.56
Net proceeds for participating holders 103,104,457.96 102,796,037.66
Fully diluted shares 32,020,018.00 24,996,874.00
Per Share Consideration 3.22 4.11
Rich Entities' Share of Per Share Consideration From Preferred 36,392,620.32 35,004,248.48
Rich Entities' Share of Per Share Consideration From Common 475,629.42 0.00
Rutchik Trust's Share of Per Share Consideration From Preferred 2,774,490.46 2,193,522.31
Rutchik Trust's Share of Per Share Consideration From Common 2,853,773.30 0.00
Rich Entities' Total Proceeds 57,692,125.96 55,828,124.70
Rutchik Trust's Total Proceeds 6,679,468.22 2,844,267.87
Stella's Share From Common 6,601,730.94 0.00
Defendants' Total Proceeds 70,973,325.12 58,672,392.57
Other Stockholders' Total Proceeds 52,955,009.06 64,947,521.31
Other Stockholders' Damages Relative To Actual Transaction 11,992,512.25
Damages As Percentage of Deal Consideration 9.70%
Rich Delta -1,864,001.26
Rutchik Delta -3,835,200.35
Stella Delta -6,601,730.94
Those are headline numbers. Any litigation involves risk, so the risk-adjusted
value of the Interested Transaction Claims would be lower. It also seems likely that the
defendants would be able to prove that Stella was entitled to an option grant of some
magnitude. His grant is quite large, and perhaps the plaintiffs are correct that a portion of
distribution. Although that hurts Rich, the higher per share distribution offsets the harm.
He also suffers relatively little from the cancellation of the Interested Grants. On net, he
loses $1.9 million when both issuances are excluded. Rutchik owned fewer shares of
Preferred Stock and received almost half of his proceeds from his option grant, so he does
worse than Rich and loses $3.8 million. Stella takes the biggest hit because he only
participated through the Interested Grants, so he loses $6.6 million. Here too, calculations
would differ if Rutchik’s holdings of Preferred Stock through Nodozac were included.
82
it represented a reward for supporting the Recapitalization and going along with the
Second Offering. See Compl. ¶ 60. But some of it (maybe most or all of it) represented
legitimate incentive compensation for his role as CEO. All of those issues can be hashed
out later in the case. At the pleading stage, it is reasonably conceivable that the value of
the Interested Transaction Claims was material.43
43
The sophisticated parties on both sides of the v. have no doubt prepared more
accurate versions of these calculations. (After all, they have the actual distribution
waterfall.) The maximum ballpark damages figure of $11.9 million tells me that with big
law firms involved on both sides, the costs of fully litigating the case to trial (including
experts) and through an appeal could easily end up in the same neighborhood as the risk-
adjusted recovery. If the plaintiffs win, then the risk-adjusted recovery likely nets out
with the litigation costs. Meanwhile, the defendants pay twice, once to fund their
litigators and a second time to pay damages to the plaintiffs. And if the plaintiffs lose,
then there is no recovery, and both sides pay once to their litigators.
A little further exploration suggests that the lawsuit could rapidly become a
negative value proposition for both sides. The plaintiffs have not sued on behalf of a
class, so they cannot claim all of the potential damages. The plaintiffs have not said how
many shares they own, so rough calculations are again the order of the day. The plaintiffs
allege that after the Recapitalization, their “ownership interest” in the Company was
15%. Id. ¶ 35. I assume that means 15% of the fully diluted equity, as if calculating
voting power. After the Recapitalization and before the Second Offering and Option
Grants, that works out to around 331,000 shares of common stock. Assuming the
plaintiffs succeed in invalidating the Second Offering and the Interested Grants, any
damages award would be shared by (i) all of the holders of common stock who received
merger consideration (including those who exercised the Disinterested Grants) and (ii)
the holders of Preferred Stock from the Recapitalization other than the shares owned by
the defendants (I again have not excluded Nodozac). That means the denominator is
roughly 16 million shares, and the plaintiffs would be entitled to 21% of the headline
damages figure. The plaintiffs’ best-case recovery becomes $2.4 million. Big firms can
burn through that before depositions start.
The venture capital players in the case market themselves as some of the best
evaluators of risk in the world. One would think they could price the case and settle it
(unless someone is feeling emotional or wants to make a point).
83
It is not necessary to engage in a similar analysis of the Disclosure Claim. That
claim provides an alternative vehicle to attack the Second Offering. As the preceding
discussion shows, the value of that claim is material.
c. Whether Snyk Would Assert The Derivative Claims
The third Primedia element asks whether the complaint challenging the merger
supports a pleading-stage inference that the acquirer would not assert the underlying
derivative claims and did not provide value for them. The facts of the complaint strongly
support an inference that Snyk will not assert the Interested Transaction Claims or the
Disclosure Claim.
When evaluating whether an acquirer is likely to assert a derivative claim and
therefore to have included value for that claim in the deal consideration, it is helpful to
divide the litigation assets that an acquirer might purchase and assert into two categories:
(i) external claims against third parties, such as contract claims, tort claims, and similar
causes of action (“External Claims”) and (ii) internal claims against sell-side fiduciaries
(“Internal Claims”).44 There is no reason to think either that an acquirer would not
determine disinterestedly whether to assert an External Claim or that the merger price
would not incorporate an assessment of the value of that claim.45 By contrast, there is
ample reason to think that an acquirer would never assert, and therefore would not pay
44
See Primedia, 67 A.3d at 483–84; Note, Survival of Rights of Action After
Corporate Merger, 78 Mich. L. Rev. 250, 263–70 (1979) [hereinafter Survival of Rights].
45
See Primedia, 67 A.3d at 483–84; Survival of Rights, supra, at 263–66.
84
for, Internal Claims.46 “Acquirers buy businesses, not claims,” and “[m]erger-related
financial analyses focus on the business, not on fiduciary duty litigation.” Carsanaro, 65
A.3d at 664.
There are also human dynamics at work that make suits against sell-side
fiduciaries improbable:
The acquiring company has just purchased the target company in a process
run by the same directors and officers who the acquiring corporation would
be suing. Would the deal have happened if the directors and officers
thought they would face a suit from the buyer? For companies who
regularly make acquisitions, a reputation for pursuing claims against sell-
side fiduciaries would not help their business model. Moreover, directors of
the acquired corporation may join the combined entity’s board, and senior
officers of the acquired company may become part of the ongoing
management team. Those individuals would become defendants in the
acquirer’s lawsuit.
Id.Finally, there are legal impediments. The acquirer may have agreed contractually
as part of the deal documents not to sue the sell-side managers.47 More likely, the
acquirer will have committed to maintain the sell-side fiduciaries’ existing
indemnification and advancement rights or provide them with even broader third-party
46
Golaine v. Edwards, 1999 WL 1271882, at *5 (Del. Ch. Dec. 21, 1999) (noting
that such claims “usually die as a matter of fact”); Penn Mart Realty Co. v. Perelman,
1987 WL 10018, at *2 (Del. Ch. Apr. 15, 1987) (“I agree that it is highly unlikely that
Pantry Pride, which now controls Revlon, will seek to redress the allegedly excessive
severance payments or allegedly excessive fees and therefore these abuses (if they are
abuses) are not likely to be addressed.”).
47
See Golaine, 1999 WL 1271882, at *4 (noting the acquirer could give up the
right to sue “in the merger agreement”); Bershad v. Hartz, 1987 WL 6092, at *3 (Del.
Ch. Jan. 29, 1987) (same).
85
rights.48 An acquirer who sued would foot the bill for both sides, making litigation
economically unattractive.
Rather than litigating a claim for breach of fiduciary duty against a sell-side
fiduciary, a buyer is likely to sue for breach of the transaction agreement, in which the
seller provided the buyer with representations about the condition of the Company. In a
private company deal, a buyer almost always has a contractual right to indemnification if
the buyer believes that it did not receive the business that it paid for. Those contractual
remedies provide superior and more certain avenues of recovery for the buyer.
Given all of these factors, an acquirer is likely to ignore any Internal Claims
against the sell-side managers and focus on “mov[ing] forward” with the business. In re
Massey Energy Co. Deriv. & Class Action Litig., 2011 WL 2176479, at *26 n.173. In the
buyer’s hands, Internal Claims “usually die as a matter of fact.” Golaine, 1999 WL
1271882, at *4.49
48
See, e.g., Homestore, Inc. v. Tafeen, 888 A.2d 204, 212 (Del. 2005)
(“[M]andatory advancement provisions are set forth in a great many corporate charters,
bylaws and indemnification agreements.”); La. Mun. Police Empls.’ Ret. Sys. v.
Crawford, 918 A.2d 1172, 1179–80, 1180 n.8 (Del. Ch. 2007) (noting arm’s-length,
third-party stock-for-stock merger agreement provided significant protections for
directors and officers of acquired company who were defendants in then-pending
derivative actions, including direct contractual indemnification from the acquirer).
49
Before Lewis v. Anderson, it was understood that the acquirer’s ability to bring
Internal Claims against sell-side fiduciaries died not only as a matter of fact but as a
matter of law. A line of cases culminating in the United States Supreme Court’s decision
in Bangor Punta held that neither the acquirer nor the post-transaction entity itself could
assert Internal Claims against sell-side fiduciaries for depressing the value of the
business. See Bangor Punta Operations, Inc. v. Bangor & Aroostock R.R. Co., 417 U.S.
703 (1974). The Bangor Punta case involved sell-side managers extracting excessive
86
The complaint’s allegations regarding the Snyk Merger, including the transaction
agreement incorporated by reference, support an inference that Snyk was buying a
value from their business before the acquisition. The Supreme Court of the United States
reasoned that because the self-dealing transactions had depressed the value of the
business, the acquirer ended up paying less to buy it. Having purchased the business for
less, the acquirer got what it paid for. The acquirer therefore had no equitable right to sue
the sell-side managers, recoup a portion of its purchase price, and effectively re-trade the
deal. Id. at 710–11. Notably, under Bangor Punta and its predecessors, this rule applied
to the acquirer both as the owner of the new business and to the extent the acquirer
sought to have the business assert the claim itself. Id. at 713; see also Midland Food
Servs., LLC, v. Castle Hill Hldgs. V, LLC, 792 A.2d 920, 929–35 (Del. Ch. 1999)
(explaining and applying the Bangor Punta doctrine); Golaine, 1999 WL 1271882, at *4
n.16 (“Depending on the circumstances, the new acquiror may be barred from causing the
target corporation [to sue its former fiduciaries] under . . . the [Bangor Punta] doctrine.”);
Courtland Manor, Inc. v. Leeds, 347 A.2d 144, 147 (Del. Ch. 1975) (same). In Lewis v.
Anderson, however, the Delaware Supreme Court declined to apply the Bangor Punta
doctrine to a surviving corporation and held that the post-transaction entity could assert
Internal Claims against the sell-side fiduciaries. 477 A.2d at 1050–51. That decision
spawned a series of difficult issues about direct versus derivative claims that have
bedeviled the Delaware courts ever since. Compare Gentile v. Rossette, 906 A.2d 91, 99–
100 (Del. 2006) (recognizing dual-natured claim for dilution), with Brookfield, 261 A.3d
at 1255 (overruling Gentile); compare also In re Tri-Star Pictures, Inc. Litig., 634 A.2d
319, 330 (Del. 1993) (using special injury test and recognizing direct claim based on
stockholder-level dilution) with Tooley, 845 A.2d at 1033 (overruling Tri-Star and special
injury test); compare also Spectra Energy, 246 A.3d at 138–39 (recognizing direct
challenge to merger based on extinguishment of standing to assert derivative claim), and
Parnes v. Bally Ent. Corp., 722 A.2d 1243, 1244–46 (Del. 1999) (permitting direct
challenge to merger based on diversion of consideration that otherwise would have
supported derivative claim), with Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 352 (Del.
1988) (holding that challenge to a transaction that diverted merger consideration was
derivative). To climb again onto a personal soapbox, a far better doctrinal solution would
be for Delaware law to apply Bangor Punta, hold that a buyer does not acquire Internal
Claims, and allow a sell-side plaintiff to continue to litigate an Internal Claim that existed
at the time of the merger for the benefit of the participants in the seller’s pre-merger
capital structure in order of their priority (which generally will mean for the benefit of the
class of common stockholders as they existed at the effective time).
87
business, not a business plus the right to assert the Interested Transaction Claims and the
Disclosure Claim against the sell-side fiduciaries. See Ex. 9. The representations and
warranties in the merger agreement concerned the Company’s business, and Snyk
bargained for a contractual indemnification regime supported by an escrow fund so that it
could recover post-closing if the Company was not in its as-represented condition.50
Unlike the plaintiffs, Snyk had no reason to be concerned about the Second
Offering or the Interested Grants. The Company represented that its capital structure
included those shares and options, and Snyk went forward with the acquisition on that
basis. See id. § 3.5. Snyk also agreed that for a period of six years after the closing, it will
cause the post-transaction entity “to fulfill and honor in all respects the obligations of the
Company to Persons who on or prior to the Effective Time are or were directors or
officers . . . pursuant to any indemnification provisions under the Charter Documents and
pursuant to any indemnification agreements.” Id. § 6.15(b).
It is reasonable to infer that Snyk will not cause the Company to challenge the
Second Offering or the Interested Grants by asserting the Interested Transaction Claims
or the Disclosure Claim. The third and final element of the Primedia test is met.
50
See id. art. 8. The high-level statement above the line about the nature of the
indemnification right is a gross oversimplification of the complex suite of provisions that
the parties negotiated to govern post-closing indemnification claims, which included
various qualifiers, limitations, baskets, and caps.
88
2. Whether The Challenge To The Snyk Merger States A Viable Claim
Meeting the Primedia test establishes that the plaintiff has standing to challenge a
merger based on its failure to provide value for derivative claims. The existence of
standing to sue does not mean that a complaint necessarily states a claim on which relief
can be granted. See Parnes, 722 A.2d at 1246 (“Although we conclude that the Parnes
complaint directly challenges the Bally merger, it does not necessarily follow that the
complaint adequately states a claim for relief.”). The court must separately analyze
whether there are grounds to second-guess the merger.
“Any board negotiating the sale of a corporation should attempt to value and get
full consideration for all of the corporation’s material assets,” including litigation assets.
Massey Energy, 2011 WL 2176479, at *3; accord Merritt v. Colonial Foods, Inc., 505
A.2d 757, 764 (Del. Ch. 1986) (Allen, C.). “The degree to which a court will examine a
board’s success at this task depends on the standard of review.” Primedia, 67 A.3d at
486. If the business judgment rule applies to the decision to approve the merger, then the
court will not second guess the board’s effort.51 If the entire fairness standard applies,
then a plaintiff who has already gained standing to sue by pleading facts supporting an
51
See, e.g., In re Countrywide Corp. S’holders Litig., 2009 WL 846019, at *8
(Del. Ch. Mar. 31, 2009) (applying business judgment rule to decision of majority-
independent board regarding merger that would affect significant pending derivative
claims where company was widely held), aff’d, 996 A.2d 321 (Del. 2010); Porter v. Tex.
Com. Bancshares, Inc., 1989 WL 120358, at *5–6 (Del. Ch. Oct. 12, 1989) (applying
business judgment rule to decision of majority-independent board to approve arm’s-
length, third-party merger that would affect standing to bring claims for
mismanagement).
89
inference that the merger consideration did not include value for the derivative claims
will have stated a claim on which relief can be granted.52
The analysis in this case is straightforward. Rich, Rutchik, and Stella were the
directors who approved the Second Offering and the Interested Grants. Their actions gave
rise to the Interested Transaction Claims and the Disclosure Claim, which were assets of
the Company. Orbit/FR, 2023 WL 128530, at *4 (explaining that a controller’s pre-
transaction looting of the company gave rise to “a chose-in-action as an asset belonging
to Orbit[] for breach of fiduciary duty”). Rich, Rutchik, and Stella then approved a sale of
the Company to Snyk that inferably did not afford any value to those assets, and the
merger simultaneously conferred a benefit on the directors by extinguishing the sell-side
stockholders’ standing to assert the Interested Transaction Claims and the Disclosure
Claim. All three members of the Board were therefore interested in the Snyk Merger, and
52
See In re Orbit/FR, Inc. S’holders Litig., 2023 WL 128530, at *4 (Del. Ch. Jan.
9, 2023) (holding that stockholder had stated a direct claim challenge to a merger where
the complaint alleged that a controller had systemically looted the company, giving rise
to a claim for breach of fiduciary duty belonging to the company, then purchased the
company at an unfair price, in part because the merger consideration afforded no value to
the derivative claim); Primedia, 67 A.3d at 486–88 (holding that plaintiff stated a claim
where the merger extinguished standing to pursue a derivative claim against a controlling
stockholder and therefore conferred a unique benefit on the controlling stockholder,
warranting scrutiny under the entire fairness test); Merritt, 505 A.2d at 765 (applying
entire fairness test where merger would affect significant pending derivative claims
against controlling stockholder); see also Kohls v. Duthie, 765 A.2d 1274, 1284–85 (Del.
Ch. 2000) (declining to apply entire fairness test where merger would affect pending
derivative claim against CEO and large stockholder, but where transaction was approved
by special committee and conditioned on tender of 85% of shares).
90
the entire fairness test applies. Cf. id. at *4 (applying entire fairness test where the
interested defendant was a controller).
For the reasons already discussed, it is reasonably conceivable that the
consideration received by the stockholders who were not affiliated with the directors was
not entirely fair because the directors approved a merger that diverted consideration to
themselves through the shares of Preferred Stock issued in the Second Offering and the
options granted in the Interested Grants. That is another way of saying that the
consideration did not afford value for the Interested Transaction Claims and the
Disclosure Claim. It is therefore reasonably conceivable that the Snyk Merger was not
entirely fair. The plaintiffs have stated a claim on which relief can be granted.
F. Count VII: The Claim That The Rich Entities Breached Their Fiduciary
Duties By Approving The Snyk Merger
In Count VII, the plaintiffs assert a claim against the Rich Entities for breach of
fiduciary duty in connection with the Snyk Merger that parallels the claim against the
directors in Count VI. For reasons similar to Count VI, Count VII states a claim on which
relief can be granted. Having addressed these issues laboriously for Count VI, this
decision will take a more abbreviated approach to Count VII.
Initially, the plaintiffs have standing to assert the challenge to the Snyk Merger set
out in Count VII under the Primedia test. The first element of the Primedia test is met
because a viable derivative claim existed against the Rich Entities based on the Second
Offering. That issuance was inferably an interested transaction with controlling
stockholders and subject to the entire fairness test. Before the Second Offering, the Rich
91
Entities could exercise all of the Preferred Stock blocking rights and controlled one third
of the Company’s voting power. They also had the ability to appoint two of the
Company’s five directors and affect the selection of the third. And in terms of the actual
facts on the ground at the time of the Second Offering, the Rich Entities controlled two
out of three directors, giving them mathematical control of the Board. That aggregation
of power makes it reasonably conceivable that the Rich Entities owed fiduciary duties as
the Company’s controlling stockholders at the time of the Second Offering. See, e.g.,
Voigt v. Metcalf, 2020 WL 614999, at *11–22 (Del. Ch. Feb. 10, 2020).
As a purchaser of shares in the Second Offering, the Rich Entities stood on both
sides of the transaction and have a burden to establish that it was entirely fair. It is
reasonably conceivable that the Rich Entities did not pay a fair price in the Second
Offering because the Rich Entities purchased shares of Preferred Stock at the same price
and on the same terms that Rich had extracted three months before, when the Company
was running out of cash, had no other options, and lacked bargaining leverage. It is
reasonably conceivable that the Second Offering was not the product of fair dealing
based on a variety of factors, including that the transaction unfolded in secret, the votes
necessary to approve the transaction came from interested parties, and there was a lack of
full disclosure. In Weinberger, the Delaware Supreme Court held that the entire fairness
standard requires compliance with the duty of disclosure.53 On the facts of the case, it is
53
Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983); accord Rabkin v.
Philip A. Hunt Chem. Corp., 498 A.2d 1099, 1104 (Del. 1985) (“[The] duty of fairness
certainly incorporates the principle that a cash-out merger must be free of fraud or
92
reasonably conceivable that the failure to disclose the existence of a preliminary, inbound
inquiry could contribute to a lack of fair process. Taken as a whole, it is reasonably
conceivable that the Second Offering was not entirely fair.
The second and third elements of the Primedia test are met for the reasons
discussed previously. The potential recovery from a challenge to the Second Offering is
material in the context of the Snyk Merger, and it is reasonable to infer that Snyk would
never assert the claim.
Having shown that standing exists to assert Count VII, the plaintiffs next must
plead that Count VII states a viable challenge to the Snyk Merger. That challenge is
viable because the Snyk Merger generated a unique benefit for the Rich Entities, the
Company’s controlling stockholders, by extinguishing the plaintiffs’ standing to assert a
derivative claim challenging the Second Offering.
misrepresentation.”). The Weinberger decision referred to the duty of disclosure as the
“duty of candor.” 457 A.2d at 711. The Delaware Supreme Court coined this phrase in
Lynch v. Vickers Energy Corp., 383 A.2d 278, 279, 281 (Del. 1977). Delaware decisions
used it consistently until Stroud, when the Delaware Supreme Court criticized the term as
potentially misleading and clarified that the duty of candor “represents nothing more than
the well-recognized proposition that directors 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.” 606 A.2d at 84. After Stroud, the prevailing
Delaware terminology shifted from the “duty of candor” to the “duty of disclosure.” But
for this history, it would be nice to use the term “duty of candor” to refer to the Malone
obligation to speak honestly and completely, while saving the “duty of disclosure” for the
obligation to disclose all material information reasonably available when requesting
stockholder action.
93
After the Second Offering, the Rich Entities still could exercise all of the Preferred
Stock blocking rights, still had the ability to appoint two of the Company’s five directors
and affect the selection of the third, and had increased their share of the Company’s
outstanding voting power from one third to 43%. And in terms of the actual facts on the
ground at the time of the Snyk Merger, the Rich Entities still had mathematical control
over the Board. That aggregation of power supports a reasonable inference that the Rich
Entities owed fiduciary duties as the Company’s controlling stockholders at the time of
the Snyk Merger. See, e.g., Voigt, 2020 WL 614999, at *11–22.
Although nominally an arm’s-length deal, the Snyk Merger conferred a unique
benefit on the Rich Entities by extinguishing the plaintiffs’ standing to assert a derivative
claim. Orbit/FR, 2023 WL 128530, at *4. The Rich Entities therefore have the burden of
proving that the terms of the Snyk Merger were entirely fair. It is reasonably conceivable
that because the Snyk Merger did not afford any value to the Company’s derivative
claim, the Snyk Merger was not entirely fair.
Count VII therefore states a claim on which relief can be granted.
G. Count VIII: The Claim That The Rutchik Trust Aided And Abetted The
Fiduciary Defendants In Breaching Their Duties In Connection With The
Snyk Merger
In Count VIII, the plaintiffs assert a claim against the Rutchik Trust for aiding and
abetting breaches of fiduciary duty by the directors and the Rich Entities when entering
into the Snyk Merger. This claim parallels the claim against the directors in Count VI and
the claim against the Rich Entities in Count VII, but seeks to implicate the Rutchik Trust
on a theory of aiding and abetting. Having reviewed the issues surrounding the Snyk
94
Merger twice, this decision again takes a more abbreviated approach. To the extent Count
VIII passes muster, it does so barely.
The initial question is one of standing. The first element of the Primedia test asks
whether it is reasonably conceivable that the Rutchik Trust could have aided and abetted
the directors and the Rich Entities in breaching their fiduciary duties in connection with
the Second Offering, thereby giving rise to a derivative claim. To plead a reasonably
conceivable claim for aiding and abetting, the complaint must allege facts to support four
elements: (i) the existence of a fiduciary relationship, (ii) a breach of the fiduciary’s duty,
(iii) knowing participation in the breach by a non-fiduciary defendant, and (iv) damages
proximately caused by the breach. Malpiede, 780 A.2d at 1096.
In light of the court’s rulings regarding the directors and the Rich Entities, the only
element at issue is knowing participation. That element involves two concepts:
knowledge and participation. To establish knowledge, “the plaintiff must demonstrate
that the aider and abettor had actual or constructive knowledge that their conduct was
legally improper.” RBC, 129 A.3d at 862 (internal quotation marks omitted). “[T]he
question of whether a defendant acted with scienter is a factual determination.” Id. Under
Rule 9(b), a plaintiff can plead knowledge generally; “there is no requirement that
knowing participation be pled with particularity.” Dent v. Ramtron Int’l Corp., 2014 WL
2931180, at *17 (Del. Ch. June 30, 2014). For purposes of a motion to dismiss under
Rule 12(b)(6), a complaint need only plead facts supporting a reasonable inference of
knowledge. See id.; Wells Fargo & Co. v. First Interstate Bancorp., 1996 WL 32169, at
95
*11 (Del. Ch. Jan. 18, 1996) (Allen, C.) (“[O]n the question of pleading knowledge,
however, Rules 12(b)(6) and Rule 9(b) are very sympathetic to plaintiffs.”).
The knowledge element is easily satisfied. When a plaintiff alleges that a third-
party acquirer knowingly participated in a breach of fiduciary duty by sell-side directors,
Delaware law imposes an appropriately high pleading burden because an acquirer is
expected to bargain in its own interest. E.g., In re Rouse Props., Inc., Fiduciary Litig.,
2018 WL 1226015, at *25 (Del. Ch. Mar. 9, 2018) (explaining that the buyer was
“entitled to negotiate the terms of the Merger with only its interests in mind; it was under
no duty or obligation to negotiate terms that benefited [the seller] or otherwise to
facilitate a superior transaction for [the seller]”). A plaintiff must plead meaningful facts
to support an inference that the acquirer attempted to create or exploit conflicts of interest
on the board or otherwise conspired with the directors to engage in a fiduciary breach.
See Malpiede, 780 A.2d at 1097–98; In re Del Monte Foods Co. S’holders Litig., 25 A.3d
813, 837 (Del. Ch. 2011). Policy reasons also lead Delaware to impose a high pleading
burden when a plaintiff alleges that a third-party advisor aided and abetted sell-side
directors in breaching their duties. Singh v. Attenborough, 137 A.3d 151, 152–53 (Del.
2016).
A case involving an affiliate of an allegedly culpable fiduciary presents a different
situation.54 The claim is simply that Rutchik caused an entity that he controlled to take
54
See, e.g., In re MultiPlan Corp. S’holders Litig., 268 A.3d 784, 818 (Del. Ch.
2022) (inferring at pleading stage that affiliate of interested controller who acted as
financial advisor for transaction aided and abetted breach of duty by controller); La. Mun.
96
action to support his efforts to effectuate an interested transaction in which he breached
his duty of disclosure and extracted value from the Company for himself. Knowledge of
that breach is imputed to the Rutchik Trust because Rutchik both controlled it and acted
on its behalf.
On the dimension of participation, Rutchik allegedly breached his duties by (i)
approving a transaction as a director that would benefit Rich and himself, (ii) voting his
shares of Preferred Stock in favor of the transaction by executing the Written Consent,
(iii) failing to disclose material information when soliciting Other Signatories to the
Written Consent, and (iv) extracting value at the expense of the Company and its other
stockholders by purchasing shares in the Second Offering. The Rutchik Trust participated
in the second and fourth steps: The Rutchik Trust was the entity that held the shares of
Preferred Stock and voted them when Rutchik executed the Written Consent on its
Police Empls.’ Ret. Sys. v. Fertita, 2009 WL 2263406, at *7 n.27 (Del. Ch. July 28, 2009)
(inferring at pleading stage that affiliated entities that controller used to effectuate an
interested transaction knowingly participated in the breach and were subject to viable
claim for aiding and abetting); see also In re Dole Food Co., Inc. S’holder Litig., 2015
WL 5052214, at *39 (Del. Ch. Aug. 27, 2015) (holding after trial that affiliated entities
that controller used to effectuate an unfair transaction knowingly participated in the
breach of duty and were jointly and severally liable with controller for aiding and
abetting the breach); In re Emerging Commc’ns, Inc. S’holders Litig., 2004 WL 1305745,
at *38 (Del. Ch. May 3, 2004) (same); Carlton Invs. v. TLC Beatrice Int’l Hldgs., Inc.,
1995 WL 694397, at *15–16 (Del. Ch. Nov. 21, 1995) (Allen, C.) (denying a motion to
dismiss aiding and abetting claims against controlling stockholder and his affiliates where
the complaint alleged “overarching control” by the stockholder such that the court could
“infer[] ‘knowing’ participation” by his affiliates).
97
behalf, and the Rutchik Trust was the entity that purchased shares of Preferred Stock in
the Second Offering.
The aider and abettor must knowingly assist another in committing a wrongful act.
The means by which an aider and abettor provides assistance need not be independently
wrongful. What nevertheless gives me pause is that the actions taken by the Rutchik
Trust do not distinguish its conduct from other holders of Preferred Stock who did the
same thing, and it seems unlikely that the plaintiffs could state claims for aiding and
abetting against all of the non-fiduciaries who participated in the Second Offering. The
principal difference is that the Rutchik Trust was Rutchik’s affiliate, whereas the other
holders of Preferred Stock were not. That distinction matters, and the cases upholding
claims against the affiliates that a conflicted fiduciary used to effectuate a transaction
indicate that the Rutchik Trust is a proper defendant on a claim for aiding and abetting.55
A better framing of the claim might be civil conspiracy. The two forms of
secondary liability are quite similar, and this court has not been a stickler for
terminology. See Albert, 2005 WL 2130607, at *10 (“While the plaintiffs caption their
claim as aiding and abetting breach of fiduciary duty, the court treats it as a claim for
civil conspiracy. Claims for civil conspiracy are sometimes called aiding and abetting.”).
Delaware decisions have largely equated the two theories, noting that they often cover the
55
See, e.g., MultiPlan, 268 A.3d at 818; Fertita, 2009 WL 2263406, at *7 n.27;
see also Dole, 2015 WL 5052214, at *39; Emerging Commc’ns, 2004 WL 1305745, at
*38; Carlton, 1995 694397, at *15–16.
98
same ground and that the distinctions usually are not material.56 Our cases have viewed
aiding and abetting as the larger, more encompassing theory, observing that “[b]ecause it
focuses on assistance, rather than agreement, aiding-abetting rests on a broader
conceptual base, one which may overlap conspiratorial conduct, or exist independent of
it.” Anderson v. Airco, Inc., 2004 WL 2827887, at *4 (Del. Super. Nov. 30, 2004)
(footnote omitted); see Great Hill, 2014 WL 6703980, at *22 (“[I]t seems likely to me
that civil conspiracy is, in many cases, to borrow a term, a ‘lesser-included’ claim within
an aiding and abetting claim . . . .”).
56
See Malpiede, 780 A.2d at 1098 n.82 (noting in reference to underlying claim
for breach of fiduciary duty that “[a]lthough there is a distinction between civil
conspiracy and aiding and abetting, we do not find that distinction meaningful here”);
Great Hill Equity P’rs IV, LP v. SIG Growth Equity Fund I, LLLP, 2014 WL 6703980, at
*22 (Del. Ch. Nov. 26, 2014) (noting in reference to underlying claim for fraud that
showing aiding and abetting would necessarily require showing “the elements of civil
conspiracy were satisfied,” and therefore “the aiding and abetting fraud claim may be
duplicative of the civil conspiracy count”); Quadrant Structured Prods. Co. v. Vertin, 102
A.3d 155, 203 (Del. Ch. 2014) (“A claim for conspiracy to commit a breach of fiduciary
duty is usually pled as a claim for aiding and abetting, and although there are differences
in how the elements of the two doctrines are framed, it remains unclear to me how the
two diverge meaningfully in substance or purpose.”); Triton Constr. Co., Inc. v. E. Shore
Elec. Servs., Inc., 2009 WL 1387115, at *17 (Del. Ch. May 18, 2009) (finding that claim
for aiding and abetting breach of fiduciary duty duplicated claim for civil conspiracy);
Benihana of Tokyo, Inc. v. Benihana, Inc., 2005 WL 583828, at *7 (Del. Ch. Feb. 4,
2005) (equating claim for aiding and abetting breach of fiduciary duty with conspiracy to
commit breach of fiduciary duty), aff’d, 906 A.2d 114 (Del. 2006); Weinberger v. Rio
Grande Indus., Inc., 519 A.2d 116, 131 (Del. Ch. 1986) (“A claim for civil conspiracy
(sometimes called ‘aiding and abetting’) requires that three elements be alleged and
ultimately established . . . .”); Gilbert v. El Paso Co., 490 A.2d 1050, 1057 (Del. Ch.
1984) (identifying the same elements for “a claim of civil conspiracy” as for aiding and
abetting), aff’d, 575 A.2d 1131 (Del. 1990).
99
There remains an important difference in emphasis between the two theories:
“[A]iding and abetting is a cause of action that focuses on the wrongful act of providing
assistance, unlike civil conspiracy that focuses on the agreement.” WaveDivision, 2011
WL 5314507, at *17. The theories align in that one way to establish knowing
participation is to show “an understanding between the parties ‘with respect to their
complicity in any scheme to defraud or in any breach of fiduciary duties.’” In re
Comverge, Inc. S’holders Litig., 2014 WL 6686570, at *18 (Del. Ch. Nov. 25, 2014)
(quoting Goodwin v. Live Ent., Inc., 1999 WL 64265, at *28 (Del. Ch. Jan. 25, 1999)).
As between Rutchik and the Rutchik Trust, there was a single human mind—
Rutchik’s—that both engaged in the breach of duty and caused the Rutchik Trust to act in
support of it. There were two distinct legal persons who could conspire together, and they
possessed more than just an agreement or understanding with respect to their complicity
in a breach of fiduciary duty; there was unity of thought. That is sufficient to support a
claim for conspiracy, pled in this setting as a claim for aiding and abetting.
With the first element of the Primedia test met, the second and third elements are
again easy. This decision has determined that the value of a derivative claim challenging
the Second Offering is material in the context of the Snyk Merger. This decision also has
determined that it is not reasonably likely that Snyk would assert the claim. The plaintiffs
therefore have standing to assert the challenge to the Snyk Merger asserted in Count VIII.
Assessing whether Count VIII states a claim on which relief can be granted
presents the same problems as the underlying derivative claim. The only element at issue
is knowing participation. Rutchik allegedly breached his duties by (i) approving the Snyk
100
Merger as a director, (ii) voting his shares of Preferred Stock in favor of the transaction,
and (iii) receiving value in the form of the merger consideration. Rutchik’s knowledge is
attributed to the Rutchik Trust, and the Rutchik Trust participated in the second and third
steps as one of the entities through which Rutchik engaged in those steps. But once again,
the actions taken by the Rutchik Trust do not distinguish its conduct from other holders
of Company equity. The difference is that the Rutchik Trust was Rutchik’s affiliate.
As before, the reasoning of cases in which this court has imposed liability on the
entities that fiduciaries control and through which they engage in transactions under a
theory of aiding and abetting indicates that the claim against the Rutchik Trust should
proceed beyond the pleading stage. So does the alternative framing of the claim as one in
which Rutchik and the Rutchik Trust engaged in a conspiracy. If nothing else, it likely
will be necessary for the Rutchik Trust to be a party to the case for purposes of relief. As
one of the entities through which Rutchik held his Preferred Stock, the Rutchik Trust
received a disproportionate share of the merger consideration, and it is logical that if the
plaintiffs prevail, then a remedial order would extend to the Rutchik Trust.
Count VIII states a claim on which relief can be granted.
III. CONCLUSION
Counts III, IV, and V are dismissed for lack of standing. The plaintiffs have stated
claims on which relief can be granted in Counts I, II, VI, VII, and VIII. This decision has
not reached the defendants’ separate argument that even if Counts VI, VII, and VIII
allege facts supporting viable claims, the plaintiffs cannot assert those claims because of
the Covenant Not To Sue.
101