In re Nine Systems: Chancery Court Finds Recapitalization with Fair Price Still Failed Entire Fairness Review, Shifts Attorney Fees as Remedy

Practical Law Legal Update 8-581-6366 (Approx. 13 pages)

In re Nine Systems: Chancery Court Finds Recapitalization with Fair Price Still Failed Entire Fairness Review, Shifts Attorney Fees as Remedy

by Practical Law Corporate & Securities

Background

The litigation stemmed from a recapitalization in 2002 of a start-up company called Streaming Media Corporation (which later changed its named to Nine Systems Corporation).

The Parties

At the time of its recapitalization, the major stockholders of Nine Systems were the defendants:

Wren Holdings, LLC.
Javva Partners, LLC.
Catalyst Investors, L.P.

These entities at the time of the recapitalization collectively owned 54% of the company's stock and 90% of its senior debt. Each of these entities also had a director designee on the board:

Dort Cameron, representing Wren.
Howard Katz, representing Javva.
Christopher Shipman, representing Catalyst.

Each of those directors were named defendants, as was Troy Snyder, the CEO and a director at the time of the recapitalization. Another Wren principal, Andrew Dwyer, was also a named defendant. Dwyer was not a member of the board, but frequently attended board meetings and was integral to the recapitalization transaction at the heart of the dispute.

The fifth director, Abraham Biderman, represented a group of minority stockholders introduced to the company through Lipper & Co., Biderman's investment firm. Biderman and Lipper were non-parties to the litigation. Critical to the allegations of unfair process, Biderman was an observant Orthodox Jew who could not transact business or attend board meetings on the Sabbath from Friday sundown until Saturday nightfall, or on any other major Jewish holiday. The other members of the board were aware of Biderman's observance.

The company was founded in 1999 in the midst of the dot-com boom, in the hopes that the company could take advantage of nascent streaming-media technology. Its founders were:

Rick Murphy, the company's first CEO.
Thomas Murphy, the company's first investor.
Rounseville Schaum, the company's first CFO.

These individuals were plaintiffs in the litigation along with the stockholders unaffiliated with Wren, Javva and Catalyst.

The Events Leading up to the Recapitalization

The company suffered cash-flow problems throughout its early years, to the point that the board members did not receive compensation for their services and the company could not afford directors and officers insurance. In April 2001, Shipman informed Biderman that Catalyst and the company's other significant investors were contemplating a $4.6 million round of equity financing as a "restart" of the company's capital structure. The proposal contemplated that various holders of the company's bridge debt, who had invested through Lipper, would convert their holdings into equity.

Several days later, certain principals at Catalyst authored a 13-page "Investment Memorandum" that outlined the conditions for Catalyst to remain invested in the company. The memo contemplated making significant changes at Nine Systems, including:

Replacing Rick Murphy as CEO and Schaum as CFO.
Shifting Lipper's investment to a debt investment.
Implementing a cost-cutting and revenue-monitoring program.
Placing control of the company under Catalyst, which was reflected in a statement in the memo which said that "[t]he Board of Directors (namely Catalyst) will control the purse strings of the Company."

As contemplated in the memo, Rick Murphy was replaced as CEO and director by (non-party) Art Williams (the predecessor CEO to defendant Snyder) and Schaum was replaced as CFO by Lorain Granberg. Before he left, Murphy suggested that, to improve its cash flow, the company acquire the streaming media group of NaviSite and a division of small competitor e-Media. Williams picked up on that idea and sought other avenues for expanding the company's customer base. By December 2001, however, the company was in a "panic," as Granberg called it, and Williams called a board meeting for Friday afternoon on December 21 to review possible solutions. The meeting, however, was scheduled too late in the day for Biderman to attend. The board realized this but did not change the time for meeting, a practice that recurred throughout the company's troubles.

Following the board meeting, Dwyer began to sketch out what would become the recapitalization. The recapitalization would consist of converting certain secured debt into a new class of preferred stock and issuing a new class of convertible preferred stock in exchange for new investment capital that would finance the e-Media and NaviSite acquisitions. Biderman only learned of these ideas on Monday in a phone call with Dwyer. In response, Biderman wrote a "harshly worded" letter in which he:

Objected to the unfair terms that would dilute existing stockholders by up to 70%.
Reminded the board to consider its fiduciary duties to the stockholders as a whole and not only those investment firms that had appointed each individual director.
Demanded to be kept informed on a timely basis of all relevant facts concerning the acquisitions.

The board did not respond to Biderman's letter.

In the beginning of 2002, the recapitalization became concrete. At a January 7 board meeting, which Biderman attended, Dwyer presented the economic terms of his proposal. The e-Media acquisition would cost $1 million in cash and a $3.6 million promissory note. The NaviSite acquisition would cost $1.3 million in cash up front and another $1.3 million in cash in one year.

Dwyer also presented to the board his valuation of the company, which he put at $4 million. Dwyer had performed this calculation on his own, with no input from financial advisors and with no back-up documentation other than Dwyer's own "handwritten scribbles." The board did not review Dwyer's calculations or ask him to explain his methods. No one at the meeting presented any other alternatives. Nevertheless, four of the five directors (Cameron, Katz, Shipman and Williams) voted in favor of the recapitalization. Biderman abstained from the vote, objecting to the lack of opportunity to review the terms and to the unfair dilution to the current stockholders. At ensuing, informal meetings, the board met to discuss the acquisitions without inviting Biderman.

At a formal meeting on January 10, 2002, the full board (with Dwyer and other investor representatives also in attendance) met and heard from Williams that the company was no longer viable as a standalone entity. The choices presented to the board were to either secure funding for the proposed transactions or liquidate. Because the company did not have enough cash in hand for the up-front payments required to make the two acquisitions, Wren and Javva agreed to lend the company $2.5 million to fund them. Catalyst was more reticent to immediately invest, but the Court concluded that the evidence showed that Catalyst was given a 90-day option to invest on identical terms. The plaintiffs, meanwhile, were not invited to invest. The board approved the new investment, with Biderman dissenting for the same reasons that he had abstained three days earlier. Following the meeting, the director defendants and Dwyer continued to hold informal meetings without Biderman to discuss the details of the preferred stock issuance and acquisitions.

At a board meeting one week later, Dwyer proposed revised terms due in part to Biderman's criticisms. The acquisitions would now be funded by creating two new series of preferred stock on slightly less dilutive terms. Under this modified proposal, current stockholders would be diluted down to 7% (instead of 3% in the January 10 proposal), the senior debt would be exchanged for Preferred A stock that would own approximately 20% of the company, and new capital would receive Preferred B stock that would represent the rest of the company's equity. Resigned to the reality that the recapitalization was going to happen, Biderman did not object again to the $4 million valuation, instead agreeing to vote in favor on two conditions:

That he remain a director through 2004 unless there were to be a change of control.
That in any subsequent capital raise other than an IPO, if the terms were not unanimously approved, any investor whose board designee dissented would be entitled to redeem its Preferred A stock at 1.5 times its face amount.

The other directors agreed to these conditions, the full board voted in favor of the recapitalization and the e-Media acquisition closed that day. The NaviSite acquisition, however, was delayed due to a shortfall in funding. To bridge the gap, certain board members and stockholder representatives met and agreed on additional capital infusions by Wren and Javva. These terms were not discussed with Biderman. The NaviSite acquisition closed on March 25, 2002, at which time Snyder joined the company.

The Recapitalization and its Aftermath

The next board meeting was scheduled for April 3, 2002, which fell during the Passover holiday and which meant that Biderman could not attend. The board refused to reschedule the meeting. The company's counsel also circulated over the Passover holiday a term sheet for a potential issuance of a new class of preferred stock and a reverse stock split. The term sheet was circulated to a representative of Javva and to Dwyer on behalf of Wren. Dwyer shared the terms with Catalyst, but no one shared them with Biderman.

At an April 11 board meeting, also not attended by Biderman, Williams resigned as CEO and Wren and Javva agreed to loan more funds to the company to make up its cash shortfall. Snyder was soon elected CEO and appointed to the board. One of Snyder's first acts as CEO was to sign over promissory notes to Wren and Javva for the $3.3 million they provided to fund the two acquisitions. Interest on the notes was initially set at 10% and accrued interest would be convertible. Later, the interest rate was retroactively increased to 12%. According to the Court, neither the convertability term nor the subsequent raise to the interest rate were authorized by the board. In addition, although Wren's note specified that it could receive no more than 34.65% of the company's total equity, it wound up receiving 39.9%. Similarly, Javva's note specified no more than 9.1% of the total equity, yet it received 11.2%.

The company implemented the final steps of the recapitalization in August 2002. On August 9, the board approved an issuance of Preferred A stock representing 23% of the company's total equity in exchange for the company's senior secured debt. However, the Preferred A did not include the 1.5x liquidation preference that the board previously agreed to as a condition of Biderman's vote in favor of the recapitalization. On August 12, the board approved an issuance of Preferred B stock representing 51% of the company's total equity to Wren and Javva for their investment to fund the two acquisitions. All told, Wren, Javva and Catalyst's combined fully diluted stock ownership in the company rose from 54% in January 2002 to 80% after the recapitalization, while the plaintiffs' aggregate holdings dropped from 26% to 2%. The company sent an update to its stockholders that described the recapitalization in general terms but that did not disclose specific details. Many of the plaintiffs testified that had they been informed and invited, they would have been prepared to invest in the recapitalization transactions.

For the next three years, the board essentially ignored the stockholders. The company held no stockholder meetings in 2003, 2004 or 2005, and did not notify the stockholders of changes like the company's move of its headquarters and its name change. In one instance in January 2005, an employee and optionholder requested to see the company's current capitalization table. Snyder flatly denied that request and explained to Dwyer that the employee "would not be happy" had he seen the table.

The 2006 Merger

During the post-recapitalization period, Snyder managed to successfully implement a turnaround plan and the company generated its first annual profit for the fiscal year ended June 30, 2006. In 2006, the director defendants began examining possible investment or sale scenarios. The company engaged Merriman Curham Ford & Co. as a financial advisor, and MCF went on a roadshow with Snyder to identify market interest in the company. Based on this research, the company decided to abandon any further equity raises in favor of a sale. The company held negotiations with various suitors, including Akamai Technologies, Inc., the eventual highest bidder. On September 29, 2006, the board held a meeting to which it did not invite Biderman and authorized the company to enter into a letter of intent with Akamai for a sale that would value the company at $175 million.

The board met again on November 15, 2006, to discuss the specifics of the Akamai transaction. Biderman attended this meeting but refused to approve the merger on the grounds that the company's early investors would not receive a comparable return to Wren, Javva and Catalyst. The rest of the board approved the transaction. On November 17, the board met again, without Biderman's knowledge, to discuss and approve minor changes to the deal terms.

After the board's approval of the merger, the company circulated proxy materials to its stockholders. These materials informed the stockholders for the first time that only Wren and Javva had received Preferred B stock. More than 94% of the company's stockholders voted in favor of the merger, attributable to Wren's 52% holdings, Javva's ownership of 16% and Catalyst's 9%. The merger with Akamai closed on December 13, 2006. The defendants received approximately $150 million of the $175 million in consideration. Those who had invested in the Preferred B stock received almost a 2,000% return.

Outcome

The plaintiffs asserted several different theories against the defendants, including direct breach of fiduciary duty, aiding and abetting, and unjust enrichment. The theories are based on a claim of expropriation, namely, that through the recapitalization, the defendants unfairly expropriated the economic and voting rights of the stockholders who did not participate in it.

The Court ruled that the plaintiffs had standing to bring their claims, because the claims of expropriation were direct in addition to derivative and therefore were not extinguished in the merger with Akamai. The Court also ruled that the conduct of the board failed entire fairness review for conflicted transactions and that this failure of process was significant enough to overcome the fact that the plaintiff stockholders did not actually lose value as a result of the disputed transactions. As a remedy, the Court acknowledged that damages would be inappropriate, but granted the plaintiffs leave to submit a petition for their attorneys' fees and costs.

The Expropriation Claims Are Direct and Derivative

As an initial matter, the Court addressed the potentially dispositive issue of standing. Because the merger with Akamai was not itself fraudulent, only direct claims could survive the merger (see Practice Note, Shareholder Derivative Litigation: Effect of Merger on Plaintiff's Standing). The Delaware Supreme Court in Tooley v. Donaldson, Lufkin & Jenrette, Inc. described a two-part test for distinguishing direct from derivative claims based on identifying who suffered the alleged harm and who stood to benefit from it (845 A.2d 1031, 1036 (Del. 2004)). However, the same set of facts can give rise to both direct and derivative claims.

In Gentile v. Rossette (Gentile II), the Supreme Court explained how an expropriation claim can be asserted both derivatively and directly. When an overissuance of shares is made to a controlling stockholder, both the corporation is harmed, because it has issued too many shares, and the minority stockholders are harmed, because economic value and voting power are transferred from them to the controlling stockholder. Thus, the corporation has a derivative claim and the minority stockholders have a direct claim flowing from the same action (906 A.2d at 99-100)). The recapitalization here, the Nine Systems court said, qualified as such an action. However, the plaintiffs would also have to demonstrate either that:

Wren, Javva and Catalyst constituted a controlling group of stockholders, equivalent to a controlling stockholder in the ordinary situation.
A majority of the members of the board were each individually conflicted.

The Majority Stockholders Formed a Control Group

A group of stockholders can be accorded controlling-stockholder status, with associated fiduciary duties owed to the remaining stockholders. However, as the Court said, "[p]roving a control group is not impossible, but it is rarely a successful endeavor" because it requires a showing of more than "mere parallel interests" (, at *24). Rather, the plaintiffs must prove that the stockholders were connected in some legally significant way, such as by contract, common ownership, agreement, or other arrangement, and that the stockholders were working together toward a shared goal.

The Court found that Wren, Javva and Catalyst each came independently to invest in the company, and that once they became investors, they had parallel interests in maximizing the value of the company. This would not be enough to establish a control group. However, the conduct of these investors beginning in mid-2001 became "more than parallel." In particular, the Court highlighted:

The Catalyst investment memo, which evidences the three stockholders' plan to implement an austerity program and control the purse strings of the company.
That once Dwyer proposed the recapitalization at the January 7, 2002 board meeting, the interests of Wren, Javva and Catalyst diverged from the interests of the other stockholders.
The knowing exclusion of Biderman from formal and informal board meetings.
The 90-day option provided to Catalyst, which was provided only to Catalyst and not disclosed to Biderman.

This conduct, the Court held, demonstrated an agreement, arrangement and legally significant relationship among Wren, Javva and Catalyst to accomplish the recapitalization.

A Majority of the Directors Were Conflicted

Alternatively, the Court examined whether the plaintiffs had direct standing under Gentile II on a theory that a majority of the board members were conflicted. In so doing, the Court first acknowledged an early understanding of Gentile II that direct standing was only available if there was a controlling stockholder or group. However, the Court determined that Gentile II did not explicitly contemplate direct standing in a situation of conflicted individual board members because that discussion would have been dictum in that decision. However, Gentile II did state that it was only addressing "one transactional paradigm" and implied that others were available as well.

The Court went on to cite its decision in Carsanaro v. Bloodhound Technologies, Inc., a decision, like Nine Systems, that also involved expropriation claims against early-stage investors in the context of a start-up (65 A.3d 618 (Del. Ch. 2013)). In Carsanaro, the Court concluded that under the "core insight" of Gentile II, stockholders could bring a direct expropriation claim against directors who issued stock to themselves at a price below market value, even if there was no controlling stockholder. The Nine Systems court called Carsanaro "a more expansive interpretation of Gentile II than other decisions" of the Court of Chancery, but not unprecedented. The Court acknowledged that Carsanaro may exceed what the Delaware Supreme Court intended in Gentile II, but that until the Supreme Court rules otherwise, the Court of Chancery would consider it correct.

In finding that a majority of the board of Nine Systems was conflicted, the Court emphasized that it is not per se improper for a director of a Delaware corporation to also be a fiduciary to another beneficiary. This situation frequently arises in the venture capital context, as was the case in Trados and Carsanaro. However, this turns into a "dual-fiduciary problem" if the interests of the beneficiaries diverge.

Here, the plaintiffs established that Cameron, Katz and Shipman (three of the five directors) were in fiduciary relationships with the investors who appointed them to the board of Nine Systems. It was also undisputed that Cameron and Katz faced a conflict of interest as a result of their dual relationships, because they approved issuances of stock to Wren and Javva. Biderman, on the other hand, was not in a conflicted situation, because Lipper did not participate in the recapitalization. The plaintiff would therefore have to prove that either Williams and then Snyder, who held the CEO seat on the board, or Shipman, representing Catalyst on the board, faced an actual conflict.

The Court held that neither Williams nor Snyder stood on both sides of the transaction because neither invested in January 2002 or any time thereafter. The Court also rejected any attempt to characterize Williams or Snyder as beholden to Wren, Javva or Catalyst.

The Court concluded that although his conflict was not as readily apparent as Cameron's and Katz's, Shipman did also face the dual-fiduciary problem. This was due to the grant to Catalyst and only Catalyst of the 90-day option to invest, which Catalyst could receive only if Shipman voted in favor of the recapitalization.

The Board Failed to Satisfy Entire Fairness

The Court reviewed the entire fairness of the transaction under that standard's two "well-known components": fair dealing and fair price (Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983)).

Fair Dealing

Specific to the fair-dealing prong, the Court examined six aspects of the recapitalization:

Biderman's role.
The process by which the board valued the company at $4 million.
The grant to Catalyst of a right to invest.
The terms of the Preferred B stock.
The board's disclosure of the recapitalization to the stockholders.
The changing of the terms of the Preferred B stock.

The Court allowed that the general initiation of the recapitalization was fair and noted management's admonition that the company had to become cash-flow positive soon or liquidate. However, the specific sequence of events undertaken by the defendants to implement the recapitalization was not fair.

The Court reviewed the pertinent facts, highlighting Biderman's repeated exclusion from important board meetings. The defendants relied on the fact that Biderman ultimately approved the recapitalization, but the Court gave that little credit due to the fact that he was marginalized from the start. The defendants also argued in their defense that Biderman did not complain to the minority stockholders that he was being marginalized or that the process was unfair, which must have meant that the process was fair. However, as the Court explained, this argument belied the defendants' flawed understanding of their fiduciary duties. Each director owes fiduciary duties to all the stockholders; directors cannot split up the stockholders into various groups and rely on one director to concern himself for a specific segment of the stockholder base.

The Court also faulted the board for not doing enough to inform itself of the details that could substantiate the $4 million valuation. The Court acknowledged that there is no per se duty to hire financial advisors to assess the merits of a transaction, but that the board still must demonstrate how it kept itself informed. Here, the director defendants had no material input into Dwyer's valuation and no insight into Dwyer's methodology.

The Court similarly found fault with the decision to favor Catalyst's interests over the other stockholders' and with the inadequate disclosures to the stockholders in August 2002 about the terms of the recapitalization. Section 228(e) of the DGCL requires delivery of notice to the stockholders when an action is approved by the written consent of the stockholders in lieu of a meeting and the consent is less than unanimous. The Court noted that "the precise parameters of the disclosure required by § 228(e) have not yet been delineated" (Dubroff v. Wren Hldgs., LLC, , at *9 (Del. Ch. Oct. 28, 2011)). However, a long-standing principle under Delaware law is that once the directors start making partial disclosures, they have an obligation to provide an accurate, full and fair description of the events they are disclosing (Arnold v. Soc'y for Sav. Bancorp, Inc., 650 A.2d 1270, 1280 (Del. 1994)). The update the board sent the stockholders after completion of the recapitalization failed to include details of the terms of the transactions and was materially misleading.

Finally, the "inexplicable" changes to the terms of the Preferred B stock in August 2002 and disregard for the Board's resolutions approving the terms of the recapitalization further benefited Wren and Javva to the detriment of the company's other stockholders. This, the Court said, compounded the evidence leading to a conclusion of unfair dealing.

Fair Price

To satisfy the "fair price" test, the directors had to establish that the valuation of the company for purposes of the recapitalization fell within a range of fairness. The defendants asserted that Dwyer's $4 million valuation was a fair price because the company's equity had no value at the time of the recapitalization. The plaintiffs contended that the company was worth $30.89 million at that time, rendering the $4 million valuation fundamentally unfair. To support their contention, the plaintiffs relied on valuations based on contemporaneous management projections, which are ordinarily deemed the most reliable. The Court agreed with the defendants, however, that under the particular circumstances of how these projections were created and revised, they were wholly unreliable.

The Court also agreed with the defendants that the proper entity to be valued was the company on a standalone basis, without the added value of the two companies it acquired. Although the acquisitions were not merely speculative, the company did not have sufficient capital to make those acquisitions on its own without the infusion of capital that came with the recapitalization. Therefore, only the value of the "old money," not the "new money," was to be evaluated.

The Court also agreed with the defendants' financial expert on several other points of discussion, including that:

Because the company did not have any earnings or positive cash flow in January 2002, the appropriate method to value the company was to use the last twelve months revenue multiples for comparable companies.
It was appropriate here to apply a private company discount, even though this is usually not permitted in the appraisal context. The company's lower quality and more variable earnings justified applying that discount in this case.

After exhaustive review of duelling expert testimony, the Court sided with the defendants' expert that the equity value of the company before the recapitalization was $0. This, the Court added, hearkened back to the Trados decision and compels the conclusion that the recapitalization was conducted at a fair price. Regardless of how much the plaintiffs may have been diluted in the recapitalization, because their common stock had no value that could have been diluted, the plaintiffs necessarily "received the substantial equivalent in value of what they had before" (73 A.3d at 76).

Unitary Conclusion on Entire Fairness

Although the Court favorably cited to the conclusion in Trados that an equity value of $0 necessarily means that the plaintiffs received a fair price, the Court did not conclude, as Trados could be interpreted, that this must mean that the transaction satisfied entire fairness.

The Delaware Supreme Court has said that "[m]erely showing that the... price was in the range of fairness... does not necessarily satisfy the entire fairness burden when fiduciaries stand on both sides of a transaction and manipulate the... process" (William Penn P'ship v. Saliba, 13 A.3d 749, 758 (Del. 2011)). Contrary to the defendants' contentions, the Court said, Trados should not be read for the broad proposition that a finding of fair price, where a company's common stock had no value, "forecloses a conclusion that the transaction was not entirely fair." The Court added in a footnote that even if Trados may be said to support a framework in which a finding of fair price strongly supports a finding of entire fairness, the fact that the company's stockholders would, after the recapitalization, remain stockholders in the company as a going concern makes Nine Systems sufficiently distinguishable from the third-party merger in Trados.

The Court went on to emphasize that the two-prong test in Weinberger has always been understood to be a unitary analysis, not a bifurcated one. For this understanding to "have any purchase," it must hold true that while the fair-price component is usually the preponderant consideration, a grossly unfair process can render an otherwise fair price, even when a company's common stock has no value, not entirely fair. Here, the Court ruled that the process employed by the board was so grossly unfair as to render the entire transaction unfair, in spite of the fact that the common stock had no value.

Equitable Remedy to Allow Shifting of Attorney Fees

The Court of Chancery has explained that self-dealing fiduciaries are liable because they breached their duty of loyalty if the transaction was unfair, regardless of whether they acted in subjective good faith (In re Primedia, Inc. S'holders Litig., 67 A.3d 455, 489 (Del. Ch. 2013)). Cameron, Katz and Shipman were interested in the unfair recapitalization that provided unique benefits to the entities to which they owed conflicting fiduciary duties. Each of these three directors engaged in self-dealing and thus breached his duty of loyalty for which they cannot be exculpated under Section 102(b)(7) of the DGCL. Snyder, by contrast, did not receive any benefit in the recapitalization, did not breach his duty of loyalty and is therefore exculpated the Section 102(b)(7) provision of the company's certificate of incorporation.

The Court cited to case law for the principle that when the duty of loyalty is breached, the court has very broad power to fashion an appropriate remedy. The plaintiffs proffered several theories for damages, the most compelling of which was that they should be awarded damages in the amount of consideration they would have received in the Akamai merger had they participated in the recapitalization pro rata. Those damages, by the plaintiffs' calculations, would be approximately $17.8 million, plus interest. Yet, what strongly undermines this theory, the Court explained, is that the defendants were under no duty to allow the plaintiffs to participate. In addition, the $4 million value attributed to the company in the recapitalization was a fair price and an award of nearly $18 million would be something of a windfall for the plaintiffs. The Court therefore concluded that it would be inappropriate to award disgorgement, rescissionary or other monetary damages to the plaintiffs.

Instead, the Court exercised its "inherent equitable power to shift attorneys' fees" and concluded that this would be an appropriate case for such a remedy. Because the parties did not fairly present this issue at post-trial briefing, the Court granted the plaintiffs leave to petition the Court for an award of attorneys' fees and costs if they so choose.

Practical Implications

The Nine Systems decision, when read together with Trados and Carsanaro, can be thought of as comprising a trilogy on fiduciary duties and remedies in venture capital transactions. The general fact pattern in which directors on the board of a start-up company make decisions that might pull value away from the minority stockholders toward the investors that appointed those directors to the board is precisely the kind of fraught situation that these decisions warn of. Carsanaro and Nine Systems together stand for the proposition that an eventual merger of the company will not extinguish stockholders' claims related to such an expropriation, even if there is no controlling stockholder or group.

Nine Systems also marks a significant break with Trados, a decision that garnered enormous attention for its conclusion that an unfair process was essentially rescued by a zero-dollar equity value. The Nine Systems decision restores the possibility that a transaction involving an unfair process will be found unfair, even if the transaction at the heart of the dispute effectively creates from scratch the value that the plaintiffs demand to share. To the extent that Nine Systems and Trados cannot be reconciled doctrinally, or if the difference between them seems to only be a matter of the grossness of the unfairness of the board's conduct, footnote 395 in Nine Systems points out a significant factual distinction between the two cases. In Trados, the unfair transaction was a merger that cashed out the minority stockholders; in such a take-it-or-leave-it scenario, the plaintiffs could never expect to receive anything of value. In Nine Systems, on the other hand, the disputed transaction was a recapitalization that left the stockholders in place. The minority stockholders could therefore fairly argue that it was unfair to them to be left out of the opportunity to participate in the transaction and receive more value in the future.

Beyond these implications specific to venture capital situations, the Nine Systems decision represents another useful admonishment to directors of all corporations to consider their fiduciary duties to all stockholders and to establish a process that is visibly fair to all stockholders and their interests.

In re Nine Systems: Chancery Court Finds Recapitalization with Fair Price Still Failed Entire Fairness Review, Shifts Attorney Fees as Remedy | Practical Law