Corporate Governance

Delaware Courts and the Validation of Misleading Disclosure: In re Transkaryotic (A License to Omit) (Part 2)

By J. Robert Brown

We are discussing In re Transkaryotic.  In this case, shareholders approved a merger by a very close vote.  In the immediate aftermath, plaintiffs filed appraisal actions.  Approximately eighteen months later, after the benefit of discovery in the appraisal action, plaintiffs filed an action for breach of fiduciary duty. 

Among other claims, plaintiffs alleged that the proxy materials were incomplete and inaccurate.  The material omissions included "material facts" about the relationship between a director on the Transkaryotic Board and the CEO of Shire, the acquirer.  

The Chancery Court's response?  It "need not determine whether the purported facts are material . . . because all of plaintiffs' disclosure claims are barred."  Why were they barred?  Without any support, the Court determined that disclosure claims could only be cured through equitable relief.  As the opinion stated:

• [T]his Court has explicitly held that a breach of the disclosure duty leads to irreparable harm. On account of this, the Court grants injunctive relief to prevent a vote from taking place where there is a credible threat that shareholders will be asked to vote without such complete and accurate information.  The corollary to this point, however, is that once this irreparable harm has occurred -- i.e., when shareholders have voted without complete and accurate information -- it is, by definition, too late to remedy the harm.  If the Court could redress such an information injury after the fact, then the harm, by definition, would not be irreparable, and injunctive relief would not be available in the first place. . . 

As a result, actions brought after the merger had been consummated would be dismissed because there was no remedy.  "I  hold that this Court cannot grant monetary or injunctive relief for disclosure violations in connection with a proxy solicitation in favor of a merger three years after the merger has been consummated and where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures." 

There are a number of observations that can be made about this holding.  First, even the Court knows it is going far out on a limb in the case because of the way it confusingly couches the holding.  While concluding that it is "too late to remedy the harm," the Court also found, alternatively, that the case must be dismissed under the waiver of liability clause adopted by the Company.  In other words, the holding that disclosure claims brought post-merger could not be remedied was entirely unnecessary. 

Second, the Court was wrong that the disclosure claims were subject to the waiver of liability provision since they arose out of allegations that implicated the duty of loyalty.

Third, after having said that a disclosure claim cannot be remedied, the Court concluded that this was only true in cases  "where there is no evidence of a breach of the duty of loyalty or good faith."  The quote suggests that disclosure violations can be remedied if they involve bad faith or breach of the duty of loyalty.  Yet this is entirely inconsistent with the Court's reasoning that once the irreparable harm occurs, there can be no remedy. 

Fourth, the reasoning is not by any stretch of the imagination limited to mergers.  Essentially, the same reasoning would apply to any disclosure case involving a shareholder vote.  In other words, once the vote occurs and the matter cannot be undone, there can be no monetary or injunctive action.  The holding, therefore, threatens to eviscerate entirely suits seeking recovery "after the fact" for false disclosure.

Fifth, the complaint alleged that had the disclosure been accurate, "the stockholders of TKT would never have approved the merger."  See Paragraph 90.  In other words, the harm was not some amorphous impairment of voting rights in a matter that passed overwhelmingly; the harm was the approval of a merger as a result of a close vote that otherwise would not have passed.  Moreover, plaintiffs alleged that appraisal did not "provide them a full remedy."

Sixth, the case is internally inconsistent.  Later in the case, the Court concedes that plaintiffs have sufficiently alleged that the votes were miscounted and the merger in fact did not pass.  But if this is true, the Court must understand that there is a remedy for plaintiffs who were subjected to a merger that they didn't approve.  The same remedy would be applicable to shareholders who were subjected to a merger that they wouldn't have approved had they been given proper disclosure. 

We have posted a copy of the opinion and many of the primary documents involved in the case  on the DU Corporate Governance web site. 

Full post as published by The Race to the Bottom on July 22, 2008 (boomark / email).