The Comstock decision arose from the transaction that generated the Delaware Supreme Court's decision in C & J Energy Services, Inc. v. City of Miami General Employees' and Sanitation Employees' Retirement Trust, 107 A.3d 1049 (Del. 2014) (see Legal Update, C&J Energy Services v. City of Miami GESERT: Delaware Supreme Court Reverses Chancery Court, Rules that Passive Market Check Satisfied Revlon). As described in more detail in the Legal Update on the decision, the Supreme Court had reversed the Chancery Court's initial decision to mandate a 30-day go-shop in the C&J/Nabors inversion deal, holding that C&J's passive market check through a fiduciary out had satisfied the board's Revlon duties. For purposes of its post-closing complaint of breach of fiduciary duties, the plaintiff highlighted several failures of disclosure that it contended were sufficient to render the approval of the stockholders for the merger less than fully informed. These included allegations that the proxy statement:

Separately, the plaintiff also argued that the transaction was appropriately reviewable for its entire fairness on two grounds:

The transaction at the heart of the Larkin decision was the acquisition of Auspex Pharmaceuticals, Inc. by Teva Pharmaceuticals Industries, Ltd. in a deal structured as a front-end tender offer conducted pursuant to Section 251(h) of the DGCL. For a summary of the merger agreement, see What's Market, Teva Pharmaceutical Industries Ltd./Auspex Pharmaceuticals, Inc. Merger Agreement Summary. The plaintiff stockholders in Larkin initially alleged that the company had made materially misleading disclosures, though they ultimately withdrew that allegation. Instead, the stockholders focused on their argument that the transaction was reviewable under the entire fairness standard.

In particular, the plaintiffs argued that the venture capital stockholders of Auspex effectively formed a controlling-stockholder group by virtue of their combined substantial ownership stakes and board representation, which they used to railroad the board into agreeing to a fast, all-cash transaction that satisfied their need for liquidity. The plaintiffs also presented two alternative theories:

Addressing the plaintiff's disclosure claims in Comstock, the court described the standard of materiality for disclosure under Delaware law: information is material and must be disclosed if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote (Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985)). This standard is met if, from the perspective of a reasonable stockholder, there is a substantial likelihood that the information would "significantly alter the 'total mix' of information made available" (Arnold v. Soc'y for Sav. Bancorp, 650 A.2d 1270, 1277 (Del. 1994)).

Continuing the Delaware judiciary's trend of deference toward board decision-making in M&A transactions, the court held that each alleged failure of disclosure did not meet this standard. For example, to the claim that the proxy statement had not disclosed the CEO's threat to scuttle the deal if he did not receive a compensation package to his liking, the court found that the threat had in fact been disclosed in a passage making reference to management's desire for "greater assurance" of their proposed employment arrangements.

The court also emphasized the axiom that Delaware law does not require a "play-by-play" of the negotiations or the competing offers that did not ultimately result in a deal. Generally informing the court's conclusions as well was the fact that the go-shop process had ultimately been rendered a nullity by the Supreme Court. The Chancery Court therefore downplayed disclosure omissions to the extent they related to bids that had arisen during the go-shop process.

The plaintiffs in Larkin contended that a combination of five of Auspex's stockholders, comprising two venture capital firms and three directors who were appointees of those firms, formed a control block whose interests competed with the company's other stockholders. The court rejected this argument in its entirety.

As the court explained, control is established under Delaware law if an individual or group either owns a majority of the company's outstanding shares or exerts control in spite of owning a minority of the shares because it wields enough voting and managerial power that, as a practical matter, it is no differently situated than if it owned a majority of the shares. Several different examples of combinations of stock ownership and board control are surveyed in Practice Note, Fiduciary Duties in M&A Transactions: Defining Control for Entire Fairness. In Larkin, the court cited chiefly to In re Cysive, Inc. Shareholders Litigation—in which a company's founder, CEO and Chairman who owned 35% of the company's outstanding stock with an option to buy more, and who also wielded influence over others to effectively give him control over 40% of the company's stock as well as day-to-day managerial control—as an example of the kind of influence that is necessary to find that a minority stockholder should be deemed a controller (836 A.2d 531 (Del. Ch. 2003)).

Here, by contrast, the court found little approaching that level of control. The venture capital stockholder block of Auspex owned a combined 23% of the shares of the company, and no facts suggested that they held untoward influence over any other directors. Contrasting the decisions in infoGROUP and Calesa Associates (also discussed in the Practice Note), the court compared the "extreme allegations" in those cases to Larkin, where there were "no allegations of either overt or even subtle bullying or that a majority of Auspex's directors were aligned with" the venture capital firms.

Even if the plaintiffs had properly alleged that the venture capital stockholder block constituted a controlling group, they would still need to demonstrate that the controlling group's interests were at odds with the remaining stockholders for the transaction to be subject to entire fairness review. Because the transaction with Teva was a third-party, arms'-length deal, the (would-be) controller was not on both sides of the transaction, necessitating a showing that the venture capital group had unique interests in a deal with Teva not shared by the other stockholders. For this proposition, the plaintiffs argued that the venture capital firms' desire to quickly exit and monetize their position in Auspex led them to conduct a rushed sales process that failed to maximize Auspex's value.

The court rejected this theory, noting at the outset that Delaware courts generally view it with skepticism for the reason that when the controlling stockholders receive the same consideration as the other stockholders, their interests are assumed to be aligned with those stockholders. For a desire for liquidity to rise to the level of a conflicting interest not shared by the other stockholders, the desire must be urgent, under circumstances that involve "a crisis, fire sale…where the controller agreed to a sale of the corporation without any effort to make logical buyers aware of the chance to sell" (In re Synthes, Inc. S'holder Litig., 50 A.3d 1022, 1036 (Del. Ch. 2012)). The demand for liquidity can involve a need for fast cash to pay debts or fund new business ventures where no other income is available. By contrast, general references to the venture capital model, in which firms expect to exit an investment after several years, without any particularized allegations of a need for liquidity on the part of the controller in the transaction at hand, does not undo the basic assumption that the controlling stockholder would be incentivized to get the best price possible for itself as much as for the unrelated stockholders.

The plaintiff in Comstock posited another theory for the application of entire fairness, arguing that Comstock tainted the board's process of considering the transaction. In Mills Acquisition Co. v. Macmillan, Inc., the Delaware Supreme Court held that the business judgment rule does not apply "in the face of illicit manipulation of a board's deliberative processes by self-interested corporate fiduciaries" (559 A.2d 1261, 1279 (Del. 1989)). For the plaintiff here to rebut the business judgment rule on this basis, it would have to demonstrate that Comstock had acted out of self-interest and deceived the rest of the board into approving the transaction.

The court held that Comstock's actions did not satisfy the standard described in Macmillan because:

Critical for the court here was that Comstock's pre-merger employment was not in jeopardy, nor was the compensation package promised to him materially better than his existing one. In the court's view, the lack of an allegation that Comstock stood to benefit from a new compensation package undercut the plaintiff's argument that Comstock was acting out of self-interest. On the contrary, and not unlike the venture capital firms of Larkin, Comstock's ownership of a 10% stake in C&J created a strong incentive for him to maximize the value of C&J's stock.

The court also held that Comstock's failure at times to inform the board of various steps he took while negotiating the transaction was not severe enough to warrant entire fairness review under Macmillan. For example, the court acknowledged the plaintiff's allegation that Comstock did not disclose an early discussion he had with the Chairman of Nabors regarding C&J management's potential future contracts with the new company. The court emphasized instead the lack of any allegation that management's eventual future roles were never disclosed to the board, or that the critical deal terms negotiated by Comstock were hidden from the board.

A significant portion of the Larkin decision is devoted to the question of whether, in spite of the fact that the transaction at issue was not a controlling-stockholder transaction, the Corwin principle should still be unavailable because of a conflicted board that makes the transaction subject to entire fairness review. The plaintiffs argued that Corwin should not apply, relying in large part on the statement in Corwin stating that "when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies" (125 A.3d at 309). The implication of this passage and the unqualified reference to the entire fairness standard is that if entire fairness is the governing standard of the transaction for any reason, be it a conflict of interest with a controlling stockholder or a conflicted board of directors, the business judgment rule cannot apply (absent the factors described in M & F Worldwide).

The Larkin court rejected this literal reading for three principal reasons:

On these bases, the Larkin court held that the Corwin principle applies regardless of the plaintiffs' allegation that a majority of the directors were not disinterested in the transaction.

Notably, the Comstock court also addressed the argument that a lack of disinterest on the part of a majority of the directors should render Corwin unavailable. However, the court did not engage in the Larkin court's analysis of the applicability of Corwin in conflicted-board transactions. Instead, the court addressed, and rejected, the plaintiff's underlying allegation of interest on the part of the directors. The plaintiff's argument that certain directors were interested in the transaction relied essentially on the promise given to them of five years of "unassailable board seats." The court considered this allegation "wholly insufficient" for establishing interest in the transaction, as the promise of a board seat has never been found to rise on its own to the level of materiality necessary to find a disabling financial interest.

The plaintiffs in Larkin argued that the transaction should not benefit from the presumptions of the business judgment rule because it was structured as a front-end tender offer, in which the stockholders do not actually cast a vote on the merger. The court cited approvingly to Volcano and adopted its reasoning for why Corwin applies equally to tender offers. For a description of the holding in Volcano, see Legal Update, In re Volcano Corp.: Delaware Court of Chancery Extends "Corwin" Rule to Tender Offer, Dismisses Claim Against Financial Advisor.

The Larkin decision is significant for its expansion of the Corwin principle to conflicted-board transactions. For stockholder plaintiffs, this is a serious development, as it could mark the beginning of a judicial trend toward allowing failures to satisfy the duty of loyalty to be cleansed by a stockholder vote.

The Comstock court did not take the opportunity to expand Corwin in the same way, but it should be noted that Chancellor Bouchard himself, in authoring the decision in KKR Financial that was upheld by the Delaware Supreme Court in Corwin, suggested the approach taken up in Larkin. In KKR, Chancellor Bouchard said, "…even if plaintiffs had pled facts from which it was reasonably inferable that a majority of [the target company's] directors were not independent, the business judgment standard of review still would apply to the merger because it was approved by a majority of the shares held by disinterested stockholders of [the target company] in a vote that was fully informed" (In re KKR Financial Hldgs. LLC, S'holder Litig., 101 A.3d 980, 1003 (Del. Ch. 2014)). Whether Chancellor Bouchard would continue to maintain post-Corwin that the Delaware Supreme Court shares that view is unclear.

The Chancery Court's decision in Chelsea Therapeutics is also relevant to this issue. That decision noted that it is unclear after Corwin if a fully informed vote of the stockholder can cleanse a bad-faith act of the board, even if disclosed (In re Chelsea Therapeutics Int'l Ltd. S'holders Litig., , at *6 (Del. Ch. May 20, 2016)). Whether a board takes an action in bad faith or while suffering from a conflict of interest, the misconduct implicates the duty of loyalty, which ought to mean that their judicial treatment is the same. Therefore, if the Chelsea Therapeutics court considered it unclear whether Corwin extends to bad-faith acts, it should be equally unclear whether Corwin extends to actions taken by conflicted directors.

Ultimately, those Chancery Court decisions that have explicitly addressed the question of conflicted-board transactions have taken the view that the Corwin principle applies, while other decisions that imply a stricter approach have not actually rejected the idea of expanding the application of Corwin. The Delaware Supreme Court has yet to specifically address the issue.