On April 8, 2014, Vice Chancellor Laster of the Delaware Court of Chancery issued an opinion addressing the reasonableness of a “market check” as well as required proxy disclosures to stockholders in M&A transactions. In Chen v. Howard-Anderson,  the Vice Chancellor held that (i) evidence suggesting that a board of directors favored a potential acquirer by, among other things, failing to engage in a robust market check precluded summary judgment against a non-exculpated director, and (ii) evidence that the board failed to disclose all material facts in its proxy statement precluded summary judgment against all directors. The opinion addresses the appropriate scope of a market check, the necessary disclosure when submitting a transaction to stockholders for approval, the effect of exculpatory provisions in a company’s certificate of incorporation, and the potential conflicts faced by directors who are also fiduciaries of one of the company’s stockholders.
Chen is a stockholder action challenging the September 2010 merger of Calix, Inc. (“Acquirer”) and Occam Networks, Inc. (“Company”). The Company had a seven-member board of directors (the “Board”), comprised of six independent directors along with the CEO. Two of the independent directors (the “Investor Directors”) were affiliated with investment funds that together held approximately 25% of the Company’s common stock.
In April 2009, the Company began to explore its strategic options. It retained a financial advisor, which identified a number of potential transaction counterparties, and the Company engaged in discussions with several of them. One potential counterparty was Acquirer, and another was Adtran, Inc. (“Competitor”). When Competitor requested information in March 2010 to assist in its development of revenue models with respect to the Company in order to prepare a potential bid to acquire the Company, the Company declined to provide such information and instead suggested Competitor use publicly available projections. In April 2010, the Company created internal revenue projections for 2010, 2011 and 2012. These projections were significantly higher than the forecasts Competitor created from the publicly available projections. The Company did not provide these internal projections to third parties, including Acquirer, Competitor and the Company’s financial advisor, all of whom used the lower publicly available projections in their evaluations of the Company.
After a series of meetings between Acquirer and the Company in May 2010, Acquirer presented an initial term sheet valuing the Company at $7.02 per share, which was significantly below Acquirer’s internal valuation of the Company. During subsequent negotiations with Acquirer, the Company provided Acquirer with a 2011 revenue estimate of $113.7 million, which was consistent with public projections, but did not provide its higher internal projections. On June 23, 2010, Acquirer increased its offer to $7.72 per share.
On the same day, Competitor confirmed its interest in buying the Company, and shortly thereafter it submitted a letter of intent to acquire the Company for cash consideration that, at the mid-point of the suggested range, provided an approximately 11% premium over Acquirer’s revised bid. The financial advisor presented its analysis of the bids at a meeting of the Board; this analysis relied on publicly available projections because the Company had not provided its internal projections to the financial advisor. On June 30, Acquirer presented its proposal to the Board, after which the Board directed the CEO to give Competitor a 24-hour deadline to make a firm bid for the Company. Competitor declined to move forward with a revised firm bid within the 24-hour period required by the Company. The Board also instructed the financial advisor to conduct a “market check.” The financial advisor then sent emails to seven potential buyers on the Thursday before the July 4 weekend. None of the emails mentioned the Company by name, and all imposed a 24-hour deadline for a response. Five of the seven recipients expressed an interest in the Company, but all five said the time frame was too short to submit a bid.
The financial advisor reported this information at a July 2 meeting of the Board, along with updated revenue information based on the Company’s internal projections, which had now been provided to the financial advisor, showing a significant increase to the financial advisor’s prior revenue projections. The Board authorized management to send Acquirer a revised term sheet, which did not counter on price. The Board also directed management to enter an exclusivity agreement with Acquirer. When the exclusivity agreement expired, the Board extended the exclusivity agreement without contacting Competitor or other potential counterparties and despite evidence that the Company’s recent performance was significantly better than its internal and publicly available projections.
In mid-August, Acquirer asked for the Company’s projections for its financial advisor’s use in preparing a fairness opinion. The Company asked its financial advisor why Acquirer was not able to rely on public projections, and the Company’s financial advisor explained that in order to prepare their fairness opinions, the financial advisors to both parties needed internal numbers as well as the Company’s explicit sign off-on the projections. The Company revisited its internal projections, reducing its market share estimates and sharply reducing its revenue forecasts. Despite having prepared forecasts for 2012, the Company only provided projections for 2010 and 2011. On September 15, 2010, the Company’s financial advisor issued a fairness opinion stating that the financial advisor had reviewed “financial forecasts for calendar years 2010 and 2011 only, having been advised by management of the Company that it did not prepare any financial forecasts beyond such period . . . .” The Board approved the sale to Acquirer, and this action was subsequently filed by stockholders holding approximately 19% of the Company’s common stock.
In addition to complaints with respect to the sale process, plaintiffs argued that the proxy statement for the merger did not contain any revenue projections for 2012, even though they would have been material for evaluating Acquirer’s offer. Plaintiffs also contended that the 2011 projections were inaccurately described in the proxy statement as providing projections for the Company on a stand-alone basis when in fact the projections assumed a merger with Acquirer that would cause the Company to lose an important account.
The Company’s stockholders approved the merger on February 22, 2011, with 64% voting in favor. Of the shares voting in favor, approximately 26% were obligated to do so under a support agreement. Of the non-obligated shares, 50.5% voted in favor of the merger.
The Chancery Court Analysis
The Court of Chancery grouped the plaintiffs’ claims into two categories: (i) breaches of fiduciary duty relating to the Company’s sale process and (ii) breaches of fiduciary duty relating to disclosures in the Company’s proxy statement. As to the sale process claims, the Vice Chancellor granted summary judgment to the disinterested director defendants only. Although the Court found that the record supported an inference that certain decisions of the Board in the sale process fell outside the range of reasonableness, insufficient evidence was offered that the disinterested directors acted with an improper motive. The exculpatory provision in the Company’s certificate of incorporation therefore insulated the disinterested directors—but not the officers—from liability. The Vice Chancellor denied summary judgment to all defendants for the proxy disclosure claims, finding the exculpatory provision ineffective because the record supported an inference that the defendants knew about the disclosure problems before approving the proxy statement.
The Company’s Sale Process
Plaintiffs contended that the Board’s requirement that Competitor make an offer within 24 hours and the financial advisor’s 24-hour, holiday weekend “market check” represented a breach of the Board’s fiduciary duties. The Vice Chancellor agreed that, under the applicable enhanced scrutiny standard of review dictated by Revlon for change-of-control transactions, the contrast between the Company’s interactions with Acquirer versus its interactions with Competitor supported an inference that the Board favored Acquirer at the expense of generating greater value from other strategic options. Noting that favoritism toward certain bidders “must be justified solely by reference to the objective of maximizing the price stockholders receive for their shares,”  the Vice Chancellor found that the defendants did not identify stockholder-motivated reasons sufficient to justify their actions at summary judgment. The Vice Chancellor also considered the Company’s failure to pursue other logical bidders vigorously, its failure to explore adequately the possibility of remaining a stand-alone company, and the deficiencies of the July 4, 24-hour market check as supporting reasonable inferences of a breach of the duty of care.
The Vice Chancellor then considered the exculpation provisions of the Company’s certificate of incorporation, which limited director liability to the Company to liabilities arising from breaches of the duty of loyalty or from actions not taken in good faith. Rejecting the arguments that nominally disinterested directors must “knowingly and completely fail to undertake their responsibilities” to fail to act in good faith, and that the only way a director could act in bad faith was by “utterly fail[ing] to attempt” to perform his fiduciary duties, the Vice Chancellor noted that the appropriate inquiry in determining whether exculpation for a breach of the duty of care applied was “whether . . . the directors acted with a purpose other than that of advancing the best interests of the corporation.” The independence of a director or directors is not dispositive, but rather whether “personal interests short of pure self-dealing have influenced the board.”
Because plaintiffs offered no evidence that the director defendants and stockholders had different economic interests, and because plaintiffs offered no plausible theory as to why the director defendants would act against such interests, the Vice Chancellor found that the director defendants acted in good faith. This holding did not apply to the CEO when acting in his role as director because of his personal interest in the transaction.  The Vice Chancellor therefore granted the defendants’ motion for summary judgment concerning the sale process claims with respect to the director defendants other than the CEO.
The Company’s Proxy Disclosures
The Vice Chancellor then examined the claims concerning disclosures made in the Company’s proxy statement, particularly whether the Company’s failure to disclose its internal projections for 2012 was a failure to disclose material information required by Delaware law to be disclosed to stockholders. Noting that “reliable” management projections of future revenues would constitute material information, the Vice Chancellor denied summary judgment because sufficient evidence existed to support an inference that the projections were reliable. This evidence included: (i) the projections were carefully created and vetted by management, (ii) at least one set of projections had been adjusted for reasonableness, (iii) the Company’s financial advisor relied on the 2010 and 2011 projections and the 2012 projections were prepared alongside those projections, (iv) the officer preparing the projections worked with the Company’s financial advisor to prepare them, and (v) the projections were shared with the Board. In addition, the proxy statement presented the description of the 2011 projections as an evaluation of the Company’s future on a stand-alone basis, but evidence suggested that the projections had been revised downwards to reflect the loss of a client that would only have been triggered if the merger of the Company and Acquirer were completed.
The Vice Chancellor also denied summary judgment on a claim that the fairness opinion disclosed in the Company’s proxy statement falsely described the information evaluated to provide the opinion. The fairness opinion claimed that the financial advisor was only provided with management projections for 2010 and 2011, but evidence existed that the financial advisor had also seen the internal 2012 projections.
Finally, the Vice Chancellor denied summary judgment regarding the insufficiency of the “background of the merger” section of the proxy statement. Acknowledging plaintiffs’ claim that the section “resembled a sales document,” the Vice Chancellor highlighted several problems with the disclosure. First, the Board failed to describe the Company’s early contacts with Acquirer, potentially “disguis[ing] the fact that Acquirer had always been the Company’s preferred bidder.” While early contacts that “do not lead to more formal negotiations” do not necessarily need to be disclosed, here the contacts with Acquirer may have been more than “bends and turns in the road.” Second, the proxy statement described Competitor as “an ‘equivocal’ and unresponsive suitor,” despite evidence that Competitor pursued a deal until “it perceived the Company’s 24-hour ultimatum as breaking off the negotiations.” Finally, the Court noted evidence that, contrary to the disclosure in the proxy statement, the Board, rather than its financial advisor, ordered the 24-hour market check, the disclosure of which might have allowed the stockholders to assess whether the Board favored Acquirer.
The Standard of Review
In addition to the opinions discussed above, the Vice Chancellor’s discussion of his decision to apply the enhanced scrutiny standard of review is illuminating.  The Vice Chancellor rejected defendants’ argument that the business judgment standard should apply because the merger had closed, citing Delaware case law that had previously applied enhanced scrutiny to closed transactions.  However, the Vice Chancellor suggested that “what could affect the standard of review for a sale process challenge (at least in my view) would be a fully informed, non-coerced stockholder vote.”  Nonetheless, in this case the deficiencies in the Company’s proxy disclosure “undermined the [stockholder] vote,” preventing it from constituting a fully informed vote. As such, the proxy deficiencies not only led to the survival of plaintiffs’ claims, but also forced defendants to meet a stricter standard of review.
The Vice Chancellor also rejected plaintiffs’ argument that the entire fairness standard should apply because five of the Company’s seven directors were not disinterested.  The Court accepted that the CEO had an interest in the merger because he would receive $840,500 in benefits not shared with the stockholders. But the Court rejected that the Investor Directors had an interest in the merger that diverged from the stockholders’ interest because: (i) the Investor Directors’ funds held securities with the same return profile and incentives as the other stockholders,  (ii) while “liquidity is one ‘benefit that may lead directors to breach their fiduciary duties,’” neither fund had shown any particular need for liquidity, (iii) because the funds’ interests were not different from the interests of the other stockholders, each Investor Director’s ties to the applicable fund did not make him interested, and (iv) a claim that two directors serve together on multiple boards is not sufficient on its own to challenge the directors’ disinterestedness.
This case addresses a significant number of issues that a board of directors of a Delaware corporation should keep in mind when conducting or considering a sale of the company. Most notably:
- In light of disclosure requirements in the proxy statement, carefully evaluate and document the reliability of internal assessments, projections and evaluations. Reliable internal assessments, projections and evaluations of a target company’s performance generally will be material to an M&A transaction and must be included in the proxy statement. When creating internal projections, management and the board should be mindful of the proxy disclosure obligation and carefully evaluate, and document its evaluation of, whether such internal materials are reliable.
- Market checks must give potential acquirers a realistic chance to respond. To be effective, a market check must provide the opportunity for an actual assessment of interest in a company. Boards should carefully consider whether responses indicating that a potential acquirer may be interested in the company but needs additional time to evaluate a potential transaction should result in an extension of the deadline in the market check.
- Carefully ensure that the disclosure provided to stockholders completely and accurately describes the sale process. Delaware state law requires that a board of directors “disclose fully and fairly all material information within the board’s control”  when soliciting stockholder approval of a transaction. In particular, the board should consider whether facts concerning the early stages of the sale process are likely to be important to stockholders in deciding whether to approve the transaction.  Boards should ensure that background sections of a proxy statement describing an M&A transaction provide a fair, complete and objective discussion of the board’s process for evaluating and approving the transaction and would not be construed as merely a “sales document.”
- Insufficient disclosure can prevent a fully informed stockholder vote, which vote may lower the standard of review. Full and adequate disclosure is a necessary prerequisite to a fully informed stockholder vote, which the Vice Chancellor suggested may result in the application of the business judgment standard of review, rather than enhanced scrutiny, of a challenged M&A transaction.
- Directors who serve as officers are not entitled to rely on exculpatory provisions of a company’s certificate of incorporation with respect to their actions not taken as a director. Officers of a Delaware corporation are not entitled to exculpation from liability for breaches of the duty of care. In addition, officers may have additional interests in an M&A transaction, such as change of control payments or severance packages, that might implicate an officer’s duty of loyalty. Boards should carefully evaluate the company’s D&O insurance policies and the indemnification offered to corporate officers to understand any risk of personal liability such officers might face in connection with an M&A transaction. In addition, Boards should consider appointing special committees that do not include officers serving as directors to evaluate and approve M&A transactions.
- The standard for determining whether a director is entitled to exculpation under Section 102(b)(7) differs depending on the operative standard of review for the particular case. Section 102(b)(7) provides exculpation only for breaches of the duty of care, not for breaches of the duty of loyalty and not for breaches made in bad faith. The Vice Chancellor’s opinion is instructive in determining what conduct constitutes a breach of the duty of loyalty and bad faith that foreclose exculpation. The Vice Chancellor rejected the directors’ argument that, because the directors did not knowingly and completely fail to undertake their responsibilities, they were entitled to exculpation. He instead explained that the loyalty and bad faith standard asserted by the directors, which assumed that the business judgment standard of review applied, was inapplicable in this case because the enhanced scrutiny standard applied. Because the enhanced scrutiny standard applied, and given that the Court had found that the directors made decisions falling outside the range of reasonableness, the appropriate loyalty/bad faith inquiry was whether the directors allowed interests other than obtaining the best value reasonably available for the Company’s stockholders to influence their decisions during the sale process.
- Directors who are also fiduciaries of significant stockholders should carefully evaluate whether there is any difference in the interests of such stockholders from the other stockholders of the company. Directors who are fiduciaries of a corporation’s significant stockholders should carefully evaluate whether the interests of such stockholders may diverge from the interests of the company’s common stockholders at large. This evaluation should consider any special rights with respect to the company that such significant stockholder may have as well as other concerns, such as a need for liquidity, that may cause the significant stockholder’s interests to diverge from those of the stockholders generally.
 Case No. 5878-VCL (Del. Ch. Apr. 8, 2014). All quotations not otherwise attributed come from this case.
 Quoting In re Topps Co. S’holders Litig., 926 A.2d 58, 54 (Del. Ch. 2007).
 The exculpatory provision also did not protect the officer defendants (including the CEO concerning actions taken in his role as an officer), because that this provision, consistent with Delaware law, only applied to directors. See Section 102(b)(7) of the Delaware General Corporation Law (allowing a corporation to include a provision in its certificate of incorporation that limits or eliminates the personal liability of a director to the corporation or stockholders for breaches of fiduciary duty other than (i) breaches of the duty of loyalty, (ii) acts or omissions not in good faith, (iii) the payment of an unlawful dividend, or (iv) transactions from which the director derived an improper personal benefit).
 Enhanced scrutiny is the standard of review that is most often applied to Delaware M&A transactions, applying when “the realities of the decision-making context can subtly undermine the decisions of even independent and disinterested directors.” Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457 (Del. Ch. 2011). It requires that fiduciaries show that they “act[ed] reasonably to seek the transaction offering the best value reasonably available to the stockholders.” Paramount Communications Inc. v. QVC Network Inc., 637 A.2d 34, 43 (Del. 1994). Accordingly, defendants must demonstrate both (i) the reasonableness of “the decisionmaking process employed by the directors, including the information on which the directors based their decision,” and (ii) “the reasonableness of the directors’ action in light of the circumstances then existing.” Id. at 45. Because the court is not to freely substitute its own business judgment for that of the directors, the relevant inquiry under enhanced scrutiny is whether a decision “was, on balance, within a range of reasonableness.” Id.
 The business judgment standard of review flows from the business judgment rule, a presumption that “in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). If this standard of review applies, a court will not substitute its judgment for that of the board if the board’s decision “can be attributed to any rational business purpose.” Gantler v. Stephens, 965 A.2d 695, 706 (Del. 2009) (internal citations and quotation marks omitted).
 Although presented as dicta, this language is consistent with the holding of the Delaware Supreme Court in Kahn, et al., v. M&F Worldwide Corp., et al., No. 334, 2013 (Del. Mar. 14, 2014), which held that, assuming certain conditions were met, a controlling stockholder transaction conditioned on the approval of an independent special committee and approved by a majority of the minority stockholders could be reviewed under the business judgment, rather than entire fairness, standard of review.
 The entire fairness standard of review is the strictest Delaware standard, which requires that the defendants prove that a transaction was entirely fair to a corporation’s stockholders based on a review of the transaction for fair dealing and fair price. See Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983).
 The Vice Chancellor compared this case to the situation in In re Trados Inc. Stockholder Litigation, 73 A.3d 17 (Del. Ch. 2013). In In re Trados, three directors had a conflict of interest based on their roles as fiduciaries of certain stockholders of the company, where such stockholders owned securities with a liquidation preference, triggered by the merger at hand, which created “a divergent interest in the [m]erger that conflicted with the interests of the common stock.” In re Trados, 73 A.3d at 47.
 Malone v. Brincat, 722 A.2d 5, 12 (Del. 1998).
 See Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985).