No breach of fiduciary duty where directors approved merger that stripped common stock of its value

Privately held company Akademos Inc. (Akademos or the Company) operated online bookstores for educational institutions. Throughout Akademos’ first decade in business, Plaintiff Brian Jacobs (the founder of Akademos) raised investments from friends, family members, and angel investors, including Kohlberg Ventures, LLC (Akademos’ former controlling shareholder, and the entity with which Akademos ultimately merged) (KV Fund), which ultimately obtained majority voting control of Akademos in 2011.

The Company had not had a single profitable year in its nearly two decades of operations, and both the Company and its investment bankers campaigned for additional investors or acquisition proposals to no avail. In July 2020, the KV Fund offered to acquire the Company in a cash-out merger at a valuation of $12.5 million, wherein shareholders would receive cash for their equity holdings. Due to the liquidation preferences associated with the KV Fund’s preferred stock and repayment premiums associated with its debt, however, Akademos’ valuation would need to reach at least $40 million before the common shares would hold any value through this transaction. As the Court noted, “[t]here was no market evidence that anyone believed the company was worth that much.”

The Company did not receive any superior or comparable offers during the three-week go-shop period, despite the fact that its investment banker re-engaged with entities that had previously shown an interest in a potential transaction. A majority of the Company’s three unaffiliated directors subsequently voted in favor of the cash-out merger. At a $12.5 million valuation, the common shareholders did not receive any value in exchange for their equity.

The common shareholders—led by Plaintiff—filed suit, alleging that the directors breached their fiduciary duties by approving this merger. The parties agreed that the entire fairness standard of review applied to this case. The entire fairness standard places the burden on the defendants to demonstrate that their actions were entirely fair to the corporation and its stockholders. More specifically, and as the Court explained, the entire fairness review considers whether the transaction was substantively fair (e.g., involved a fair price) and procedurally fair (e.g., the fiduciaries engaged in fair dealing).

Although the common shareholders did not receive any value for their equity, the Court held that the Company merged for a fair price in light of the KV Fund’s status as the controlling shareholder, the Company’s capital structure, and the Company’s poor financial health history. As the controlling shareholder, the KV Fund could have vetoed any transaction that did not first pay off the debt held by KV Fund and satisfy the liquidation preference on KV Fund’s own preferred equity in Akademos. These amounts exceeded what anyone would pay for the Company. And the Court viewed the fact that Akademos did not receive any competing offers during the go-shop period as further proof that the shareholders’ equity held no value. As such, the Court found that although the stockholders did not receive any monetary payout through the cash-out merger, they received the substantial equivalent of what they had before the merger, and therefore, the transaction was substantively fair. Further, the Court concluded that the evidence supporting the fair price analysis was sufficiently strong to conclude that the transaction was entirely fair without any inquiry into whether the fiduciaries engaged in fair dealing. Thus, the Delaware Court of Chancery concluded that the defendants did not breach their fiduciary duties, nor aid and abet in the breach of any fiduciary duties.

This case makes clear that a corporate merger need not always generate value to common shareholders in order to withstand challenge. It also enforces the idea that so long as shareholders receive value equivalent to what they held prior to the merger, a merger can be found to be substantively fair.

Authored by Christopher Pickens, Allison M. Wuertz, Molly Balan, and Jacey Gottlieb.