Chancery Denies Corwin Cleansing In Light of Process Concerns
Last month Vice Chancellor Zurn issued a significant, 200+ page decision on a motion to dismiss filed by defendants in the ongoing Pattern Energy transaction litigation, captioned In re Pattern Energy Group Inc. Stockholders Litigation, C.A. No. 2020-0357-MTZ. As we previously reported, class actions had been filed in Chancery Court and Delaware Federal District Court following the $6.1 billion going-private sale of Pattern Energy Group, Inc. to Canada Pension Plan Investment Board (“Canada Pension”). Both cases present overlapping breach of fiduciary duty claims. The Chancery Court case has moved forward faster, with that Court now issuing a decision denying defendants’ motion to dismiss. The decision is a reminder to directors and their advisers that without careful adherence to an independent sales process and transaction structure, directors risk losing the liability protections that Delaware law otherwise provides.
The Sales Process
Pattern Energy was formed nine years ago by Riverstone Pattern Energy Holdings, L.P.(“Riverstone”), a private equity fund, for the purpose of operating renewable energy facilities developed by another Riverstone affiliate. (The summary of pertinent background facts is taken from the Chancery Court’s lengthy recitation of transaction found in its Order from pages 4 to 81.) Riverstone is not a Pattern Energy stockholder. Instead, plaintiffs alleged that Riverstone exercised control through Pattern Energy’s primary upstream supplier of energy projects (“Supplier”), which provided most of Pattern Energy’s business. Pattern Energy was itself a limited partner in Supplier, and Riverstone controlled Supplier. Importantly, the applicable partnership agreement prohibited Pattern Energy from selling its stake in Supplier without Supplier’s consent, although a transaction could potentially be structured to avoid triggering this consent right. This effectively gave Riverstone (through Supplier) a veto right on a sale of Pattern Energy’s stake in Supplier.
In addition to the tangled corporate structure, Riverstone was also alleged to have exercised control over Pattern Energy through various overlapping fiduciaries that served as Pattern Energy officers and directors. Pattern Energy’s CEO, CFO, and president all had longstanding relationships with Riverstone and Supplier. In addition, two members of Pattern Energy’s seven-member board had been appointed by Riverstone, including Michael Garland, who was also CEO and Supplier’s president. However, there were no allegations that any of the other five members of the board were conflicted.
In 2018, the board decided to engage in a sales process and formed a special committee of the five disinterested directors to conduct that process (the “Committee”). The Committee, however, allegedly delegated primary responsibility for engaging potential bidders to Garland, and also permitted the other conflicted director to attend Committee meetings as Riverstone’s representative, including executive sessions. The Committee initially developed an offer from
Brookfield Asset Management, Inc., which submitted a term sheet in March 2019 that structured a deal to avoid triggering Supplier’s consent right. In April 2019 and without the Committee’s knowledge or approval, Garland attended a meeting between Riverstone and Canada Pension, a pension fund that had previously invested over $700 million in Riverstone funds. At the next Committee meeting, Garland suggested Canada Pension as a potential bidder without disclosing the Riverstone-Canada Pension meeting.
As the Committee continued its work, it received advice from Garland and Pattern Energy’s chief legal officer (who was also an officer of Supplier) that because of the Supplier consent right, any potential merger would require Riverstone’s agreement. This was not correct. The Committee also instructed bidders that it preferred a transaction that included the purchase of Supplier. However, this would cause a bidder to have to spend money to acquire Supplier as well as Pattern Energy, which would cause Pattern Energy stockholders to be competing with Supplier for transaction consideration.
Brookfield and Canada Pension submitted final offers in October 2019. Brookfield proposed a stock-only transaction that offered Pattern Energy stockholders a 45% premium, but was not predicated on a transaction involving Supplier. Canada Pension made an all-cash offer at a 14.8% premium and also included an offer to buy Supplier at 1.8 times the amount of Riverstone’s invested capital. Unlike Brookfield’s proposal, Canada Pension’s offer would allow Riverstone to maintain equity in Supplier, and Pattern Energy’s and Supplier’s management would remain in place. In response to Brookfield’s offer, the Committee insisted that it include an agreement with Riverstone regarding Supplier. As a consequence, Brookfield withdrew its offer, and the board approved a transaction with Canada Pension.
The board delegated all authority to the company’s officers to draft the merger proxy and did not review the proxy or supplemental disclosures before they were disseminated. 52% of Pattern Energy stockholders voted in favor of the merger. Crucially, 10.4% of those shares were voted by CBRE Caledon Capital Management Inc. The CBRE shares had been issued a year earlier in a private placement, and under the applicable terms CBRE was required to vote in favor of any future merger recommended by the board.
MTD Decision and Key Points
In denying defendants’ motion to dismiss, the Chancery Court rejected arguments that liability was exculpated by Pattern Energy’s charter because of sufficient allegations of bad faith, and rejected the argument that the merger vote “cleansed” the transaction under Corwin v. KKR Financial Holdings, LLC.
The Court’s rejection of exculpation is significant because, at least at the surface level, Pattern Energy ran a standard, independent sales process. Many of the usual approaches, including creation of an indisputably independent Committee, were employed here. Order at 137-39. However, the manner in which the Committee operated was deemed problematic. Order at 139-69. Although the Committee established guidelines for the conduct of conflicted management, those guidelines were ignored, and even after the Committee learned that the guidelines had been ignored, it continued to delegate authority to conflicted management during both the sales process and proxy drafting process, thus allowing conflicts to infect the Committee’s process. The problem of improper delegation and involvement by conflicted individuals was reinforced by the Committee’s own insistence on deal terms that were favorable to Riverstone, particularly with regard to the treatment of Supplier, and the decision to proceed with a transaction with Canada Pension despite the Committee’s own conclusion that the Brookfield offer was superior. Taken together, plaintiffs’ allegations of bad faith persuaded the Court that the existence of the otherwise independent Committee was not enough for the directors to invoke exculpation. The Court also noted that plaintiffs’ allegations of the directors’ bad faith fit within a “paradigmatic Revlon theory,” and that when such allegations are made “they will generally be sufficient to support a nonexculpated claim at the motion to dismiss phase.” Order at 134-35.
Importantly, the allegations of a flawed sales process were set against compelling allegations that Riverstone was acting as a controller, and that Riverstone — together with Supplier and conflicted officers and directors — formed a control group. While the Court noted that it is an “open question” of Delaware law as to whether the soft power of entities alone are sufficient to support a finding of control, the Court here, based on plaintiffs’ allegations, approved of such a finding. Order at 107. In particular, the Court credited plaintiffs’ allegations about Riverstone’s history with Pattern Energy, the relevance of Supplier’s consent right, the existence of overlapping fiduciaries, and the involvement and influence of those fiduciaries in the sales process. Order at 116-128. The decision is an important reminder that control need not only be in the form of voting power, since Riverstone and Supplier had no such power, and that care must be given to any role played by interested entities and individuals in the sales process.
Finally, the Chancery Court rejected defendants’ arguments the disclosures made to stockholders together with the vote of the disinterested minority of stockholders was sufficient to cleanse the transaction. Once the board authorized the transaction, it delegated to the Company’s officers the responsibility to draft and disseminate the merger proxy, just as most companies do. But here the delegation went too far and constituted an “abdication.” Order at 162- 69. The Court found the extent of delegation improper because the board did not even retain for itself authority to review and approve the final disclosures. This resulted in certain alleged false and misleading disclosures. While delegation is not itself impermissible, this decision is a good reminder that care must be taken in both the extent of delegation and to whom delegation is made. The board cannot leave the responsibility of disclosure entirely to conflicted officers, and in no event should a board and its advisers absolve themselves of reviewing proxy disclosures before they are made.
The Chancery Court further found that defendants’ arguments for cleansing of the transaction (and application of the business judgment rule) under Corwin would be improper because there was no vote in favor of the transaction by a fully informed, disinterested minority of stockholders. Order at 170-80. In order to achieve the requisite vote total of the non-interested minority, the votes of CBRE (roughly 10% of the total) had to be included in the count. But CBRE’s vote was dictated by the terms of a contract executed more than a year prior. By definition it was not “fully informed” and was coerced by punitive contractual penalties should CBRE have voted contrary to the board’s recommendation.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.
