Director Wins In Claim of Improper Removal – But Still Loses
In Barbey v. Cerego, Inc., the Delaware Supreme Court affirmed a post-trial judgment denying relief to the plaintiffs in a Section 225 action, despite what the court called the “unusual and troubling circumstances of [the] case.” The Supreme Court’s decision illustrates the limitations of Section 225 proceedings. The underlying Court of Chancery decision shows that voiding board actions may in some cases have no practical effect, even when a board acts in the context of entity-altering corporate transactions.
The plaintiffs in Barbey were an ousted Cerego, Inc. director and the foundation the director represented. Cerego, a Delaware corporation, was the parent of Cerego Japan, Inc. (CJ), a wholly-owned subsidiary and a Japanese entity. Cerego and CJ effected an “inversion,” in which their positions flipped. Cerego became the subsidiary and CJ became the parent company. The inversion was accomplished by means of a tender offer: CJ solicited Cerego’s stockholders to tender their Cerego shares in exchange for shares in CJ. When the tender offer was complete, CJ owned a supermajority of Cerego’s shares. CJ used its supermajority power to remove the entirety of Cerego’s board, replacing it with a single new director of CJ’s choosing.
The precondition for the board ouster was the successful tender offer, and the precondition for the tender offer was — or appeared to be — a board meeting in which Cerego’s directors authorized CJ to conduct the tender offer. The ousted director, Kelly Barbey, challenged his removal from the board under Section 225. The focus at trial was the board meeting at which CJ obtained authority for the tender offer. Barbey succeeded in showing that the board meeting was improper, and that the action taken at the meeting was void. The Court of Chancery agreed with Barbey that the meeting was a special rather than a regular meeting under Cerego’s bylaws, which meant that notice was required. The court also agreed with Barbey that he did not receive the notice to which he was entitled under the bylaws.
The evidentiary issues related to notice were unusual. The parties “hotly contested” whether Barbey received a company email providing notice. Barbey presented forensic evidence from a private investigator showing that he never received the email. The defendant’s evidence consisted of screenshots that appeared to show otherwise. The Court of Chancery concluded that the screenshots established the opposite of what defendant sought to show. The screenshots were “weak evidence”; the “strong evidence” would have been the email itself in its native format. The Court of Chancery concluded that the screenshots were almost worse than nothing. “The production of weak evidence when strong is, or should have been, available can lead only to the conclusion that the strong would have been adverse.” The screenshots therefore established that Barbey did not receive the email providing notice.
The consequences appeared to be severe. Citing century-old precedent, the Court of Chancery held that a special meeting conducted without due notice to all directors is not lawful, and that all acts taken at such a meeting are void. But in a surprising turn, the court then concluded that absolutely nothing followed from this. Barbey’s assumption was that if the board’s authorization of the CJ tender offer were void, then so was the tender offer itself, and so too was the board ouster CJ effected with its supermajority ownership. But Barbey neglected to prove a critical link in this chain at trial. He never established that CJ needed board authorization to conduct the tender offer in the first place.
That was fatal. Barbey had proceeded, the court explained, “as though the inevitable result” of voiding the board’s actions “would be the invalidity of CJ’s Tender Offer, which gave CJ majority ownership of Cerego and the ability to replace the Board.” But Barbey did not prove this was the case. CJ’s ability to conduct a tender offer in the absence of authorization from its parent was governed by Japanese law, and Barbey did not address Japanese law. The court rejected Barbey’s argument that he did not bear the burden on the issue, and similarly rejected Barbey’s post-trial submissions addressing Japanese law for the first time.
The Supreme Court affirmed in a three-page order, although it viewed the issue somewhat differently. To the Supreme Court, what stood in the way of relief was not Barbey’s failure to prove an element of his claim but instead the limitations of Section 225. “It appears that Barbey could be restored to the board only by unwinding the stock swap, which would require an analysis of Japanese corporate law and which might affect the rights of hundreds of stockholder that are not parties, in a representative capacity or otherwise.” The court reasoned that while Section 225 empowers courts to determine proper board composition, it “does not permit the court to go further and actually rescind a transaction procured through . . . unlawful behavior.” The Supreme Court’s approach suggests that even if Barbey had shown that CJ needed board authorization to conduct the tender offer as a matter of Japanese law, the Court of Chancery could not have granted relief, despite the “unusual and troubling circumstances” of the case. The existence of an ongoing parallel plenary action made that result less problematic to the Supreme Court, as the plenary action could conceivably lead to relief of some kind for Barbey.
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.
