29 June 2022

Delaware Chancery Court Examines Independence of Board Members Nominated by Activist Investors

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A recent Court of Chancery decision may signal increased scrutiny of the independence of directors repeatedly placed on boards by activist investors.

On May 26, 2022, Vice Chancellor Laster issued the first installment of a two-part decision denying the motions to dismiss filed in Goldstein v. Denner. The litigation is grounded in the decision made by the board of directors of Bioverativ, Inc. (the “Company”) to merge with Sanofi S.A (“Sanofi”). In May 2017, Sanofi expressed interest in a transaction to two Company directors. These included Defendant Alexander J. Denner, an activist investor responsible for placing a number of key directors on the Company’s board. Denner did not disclose the offer to the Company’s board of directors. But he allegedly directed hedge fund entities he controlled (collectively, “Sarissa”), to purchase over one million shares of the Company’s stock, in violation of the Company’s insider trading policy.

Plaintiffs alleged that in order to circumvent Section 16(b) of the Securities Exchange Act of 1934, (which requires an insider to disgorge short-swing profits from any sale that occurs within six months of purchase), Denner rejected Sanofi’s repeated attempts to purchase the Company until the six month short-swing period expired in November 2017. Soon thereafter, the Company’s board agreed to the acquisition, allegedly at a price almost one-third below the Company’s standalone long-term planning model.

A stockholder plaintiff subsequently filed suit alleging that various directors and officers breached their fiduciary duties by (i) failing to make requisite disclosures, (ii) approving, falsifying, and omitting material information from key documents related to the transaction, and (iii) failing to secure the highest value for the Company’s stockholders in favor of the board members’ own self-interest. The Complaint further charges that Denner engaged in insider trading, and that Sarissa aided and abetted this breach of fiduciary duty.

Although Part I of the Vice Chancellor’s motion to dismiss discusses numerous issues, of particular note is the focus on whether directors acted independently of Denner in authorizing the transaction. Delaware law has long held that a director may lack independence due to a sense of gratitude for past benefits conferred. Recent scholarship indicates that the same may be true when a director is promised future benefits. The Court explained that the receipt of past directorships and access to a steady flow of future board opportunities—such as those generated and secured by activist investors—may be sufficient to compromise a director’s independence: “Although a director’s nomination to a board standing alone is not enough to call into question the director’s independence from the nominating party, a pattern of facts surrounding the director’s service can do the trick.”

Plaintiff alleges that four board members were beholden to Denner and, as such, were not independent from him. The Court quickly rejected the claim that one board member was obligated to Denner because both Defendants served on Bioverativ, Inc.’s parent corporation’s board since 2009, were placed on that board by activist investor Carl Icahn, and because Icahn previously nominated the board member to the board of Yahoo!. The Court likewise rejected the scant claim that another board member lacked independence from Denner because Denner appointed him to serve on the board of Sarissa’s acquisition company.

But other director independence allegations presented a “close call.”  One director had previously supported and financially benefited from a similar transaction Denner had orchestrated. Less than two weeks later, Denner appointed that same director to a position on Bioverativ’s board. The Court held that, when viewed in tandem with Denner’s “practice of rewarding directors with other lucrative directorships on other Sarissa-affiliated boards” and the allegedly dubious sale terms, the allegations were sufficient to support a reasonable inference that the director was not acting independently of Denner. Similarly, the Court ruled that it was reasonably conceivable that a board member who was unemployed prior to Denner’s securing him a seat on the Bioverativ board, and who was also placed on an additional board by Denner which resulted in a $3 million gain, was not independent of Denner. Thus, the court ultimately found that at least half of the six-person board, including Denner, was either potentially interested in the transaction or lacked independence in rendering the decision to effect the merger.

Although the Court held that these facts allowed Plaintiff’s claims to survive the pleading stage, the opinion also emphasized that: “Outside of a Rule 12(b)(6) motion in a case governed by enhanced scrutiny, it is unlikely that a similar constellation of facts would be sufficient to overcome the presumption of good faith or to call a director’s independence into question…Nor is it clear that the same constellation of facts would render [the board member] non-independent for purposes of rebutting the business judgment rule and causing entire fairness to apply.”

The general principles regarding independence and the fact-specific approach taken to evaluate independence, are longstanding tenets of Delaware law. But the application of these principles to directors repeatedly placed on boards by activist investors is less common, and may be seen as citations in future cases involving activist stockholders who engage in repeat director appointments.