SOUTHEASTERN PENNSYLVANIA TRANSPORTATION AUTHORITY, individually, and on behalf of all those similarly situated, Plaintiff,
ERNST VOLGENAU, JOHN W. BARTER, LARRY R. ELLIS, MILES R. GILBURNE, W. ROBERT GRAFTON, WILLIAM T. KEEVAN, MICHAEL R. KLEIN, STANTON D. SLOANE, GAIL R. WILENSKY, SRA INTERNATIONAL, INC., PROVIDENCE EQUITY PARTNERS LLC, PROVIDENCE EQUITY PARTNERS VI L.P., PROVIDENCE EQUITY PARTNERS VI-A L.P., STERLING PARENT INC., STERLING MERGER INC. and STERLING HOLDCO INC., Defendants.
Date Submitted: April 4, 2013
Pamela S. Tikellis, Esquire, Robert J. Kriner, Jr., Esquire, A. Zachary Naylor, Esquire, Tiffany J. Cramer, Esquire, and Vera V. Gerrity, Esquire of Chimicles & Tikellis LLP, Wilmington, Delaware, Attorneys for Plaintiff.
David J. Teklits, Esquire and Kevin M. Coen, Esquire of Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware, and John C. Millian, Esquire, Justin A. Torres, Esquire, and Eric C. Schmale, Esquire of Gibson Dunn & Crutcher LLP, Washington, D.C., Attorneys for Defendant Ernst Volgenau.
Brian C. Ralston, Esquire and Justin Morse, Esquire of Potter Anderson & Corroon LLP, Wilmington, Delaware, and James P. Gillespie, P.C., Robert B. Gilmore, Esquire and Dana E. Hill, Esquire of Kirkland & Ellis LLP, Washington, D.C., Attorneys for Defendants SRA International, Inc., John W. Barter, Larry R. Ellis, Miles R. Gilburne, W. Robert Grafton, William T. Keevan, Michael R. Klein, Stanton D. Sloane, and Gail R. Wilensky.
Raymond J. DiCamillo, Esquire and Susan M. Hannigan, Esquire of Richards, Layton & Finger, P.A., Wilmington, Delaware, and Maeve O'Connor, Esquire, Elliot Greenfield, Esquire, and Michael T. Leigh, Esquire of Debevoise & Plimpton LLP, New York, New York, Attorneys for Defendants Providence Equity Partners LLC, Providence Equity Partners VI L.P., Providence Equity Partners VIA L.P., Sterling Parent Inc., Sterling Merger Inc., and Sterling Holdco Inc.
NOBLE, Vice Chancellor
This case arises from the merger between a private equity sponsor and a former Delaware corporation. As part of the transaction, the controlling stockholder received a minority interest in the merged entity, a non-recourse note, certain authority in the private entity, and, in exchange for fifty-nine percent of his shares, $31.25 per share in cash. Minority stockholders received $31.25 per share in cash. A former minority stockholder has brought fiduciary duty claims against the former directors of the acquired company relating to their conduct in approving the merger and an aiding and abetting claim against the buyer (collectively, the "Defendants"). In addition to alleging that the controlling stockholder engaged in self-dealing, the former stockholder alleges that the merger was consummated at an unfair price, through an inadequate process, and in violation of the company's charter. The Defendants have moved for summary judgment.
At the center of the Defendants' motion is whether robust procedural protections were used that entitle the merger to review under the deferential business judgment rule instead of the exacting entire fairness standard. A transaction involving a third party and a company with a controller stockholder is entitled to review under the business judgment rule if the transaction is (1)recommended by a disinterested and independent special committee and (2)approved by stockholders in a non-waivable vote of the majority of all the minority stockholders.
Because of the procedural protections that were used, the Court reviews the merger under the business judgment rule. The Court concludes that there is no dispute of material fact that the merger-related decisions of the directors of the former company were attributable to a rational business purpose and that the buyer was an arms' length bidder. The former shareholder asserts a duty of loyalty claim against the directors for consciously disregarding a provision in the company's charter requiring that the controlling stockholder receive "equal" consideration as all other stockholders in a merger. Because there is no dispute of material fact that the former directors did not act in bad faith, and because the Defendants are entitled to judgment on all claims asserted against them, the Court grants the Defendants' motions for summary judgment on all counts.
The Plaintiff, Southeastern Pennsylvania Transportation Authority ("SEPTA" or the "Plaintiff"), brings claims arising from the buy-out (the "Merger") of Defendant SRA International, Inc. ("SRA" or the "Company") by Defendants Providence Equity Partners LLC ("Providence") and its related entities. SEPTA asserts fiduciary duty claims against the former directors of SRA (the "SRA Directors" or the "Board"), who include Ernst Volgenau ("Volgenau"), the former controlling stockholder of SRA, and Stanton D. Sloane ("Sloane"), the former chief executive officer ("CEO") of SRA, relating to their conduct in connection with the Merger. SEPTA also asserts that Providence aided and abetted the SRA Directors' breach of their fiduciary duties.
A. An Overview of the Claims
SEPTA has asserted four claims in its Verified Second Amended Class Action Complaint (the "Complaint").
• Count I asserts a breach of the duty of loyalty and duty of care against the SRA Directors (including Volgenau) for approving the merger agreement, disclosing misleading or incomplete information, and failing to disclose material information.
• Count II asserts a breach of the duty of loyalty and duty of care against Volgenau and Sloane. Volgenau is accused of "planning, structuring and timing the [Merger] to benefit himself . . . at the unfair expense of the stockholders and in violation of the equal treatment provision of the Certificate of Incorporation." Sloane is alleged to have "encourage[d] and facilitate[d] the [Merger]" and Volgenau's self dealing conduct.
• Count III asserts that Providence aided and abetted the SRA Directors' breach of fiduciary duties in Counts I and II.
• Count IV asserts that the SRA Directors breached their fiduciary duties by approving the Merger in violation of SRA's certificate of incorporation (the "certificate" or "charter").
B. Procedural History
Following the announcement of the Merger, SEPTA filed its original complaint on April 7, 2011. Thereafter, it filed a Motion for Preliminary Injunctive Relief based on unresolved disclosure claims, but withdrew its motion when the Defendants made supplemental disclosures. On June 21, 2011, the Plaintiff filed its most recent Complaint. The SRA Defendants filed a Motion for Judgment on the Pleadings as to Count IV, which the Court granted in part and denied in part. The Court held that "SEPTA's claim that the Merger is invalid fails as a matter of law" under 8 Del. C. § 124. However, the Court denied the Defendants' motion to dismiss "SEPTA's claim that [the SRA Directors'] breached their fiduciary duties by approving a transaction that violated SRA's certificate of incorporation."
SEPTA was a stockholder of SRA at the time of the Merger. Volgenau founded SRA in 1978. SRA is a leading provider of technology solutions and professional services, primarily to the federal government. SRA serves customers in four markets: national security, civil government, health, and intelligence and space. At the time of the Merger, Sloane was SRA's CEO. The Board consisted of Volgenau, Sloane, Klein, Gilburne, Grafton, Barter, Ellis, Keevan, and Wilensky.
Providence is a private equity firm specializing in equity investments in media, communications, information services, and education.
D. History of SRA
Volgenau has been SRA's controlling stockholder from its inception in 1978. In 2002, the Company made an initial public offering. As a public company, SRA had two classes of common stock: Class A and Class B. The only difference between the two classes of stock was that a holder of Class A stock was entitled to one vote per share, while a holder of Class B stock was entitled to ten votes per share. Despite owning only 21.8 percent of the outstanding equity of the Company, Volgenau retained control of SRA through his ownership of Class B common stock, which enabled him to control approximately 71.8 percent of the voting power.
Under the terms of SRA's certificate, Volgenau could convert—at any time—each share of his Class B common stock to one share of Class A common stock. Each Class B share was also subject to an automatic conversion at the same one-to-one ratio upon the occurrence of certain events, such as the death of the holder, loss of competency, and if the holder became eighty years old and was no longer affiliated with the Company. The certificate also required that the holders of Class A and Class B common stock be treated equally in the event of a merger.As Volgenau testified in his deposition, the "primary objective in having Class B stock was to prevent harmful takeovers of the company, not to enrich the Class B shareholders."
SEPTA asserts that Volgenau dominated and controlled SRA. There is no doubt that Volgenau, even after stepping down as SRA's CEO in 2002, exercised considerable influence over the operations of the Company in his capacities as Chairman of the Board and controlling stockholder. Volgenau actively participated in the selection of his replacement, Renato DiPentima ("DiPentima"), and DePentima's successor, Sloane. As the Company struggled under Sloane, he regularly conferred with Sloane on all "major decisions." Perhaps neither of these actions is unusual for a Chairman. But, as a controlling stockholder, Volgenau's influence was more pervasive. When Sloane terminated the employment of a valuable executive, Volgenau arranged to keep the former employee engaged as a consultant to SRA. As SRA struggled under Sloane, SRA began considering possible strategic alternatives, including a sale of the Company. During that time, Volgenau was actively involved in the decision to pursue a strategic transaction and in ensuring that the Company's ethics of honesty and service would be preserved.
SEPTA attempts to cast a negative light on Volgenau's insistence on preserving the Company's values and culture, asserting that it had a "negative economic impact." Whether that is true or not, Volgenau testified that "many people believe that honesty and service increased the market value of . . . SRA." At least initially, Volgenau's views affected his willingness to consider a sale of the Company to a strategic acquirer. In his book, Volgenau candidly admits that he had a negative disposition to that type of buyer.
Virtually every year since our founding I had been approached by a CEO in a company that wanted to buy SRA. In each case I declined, explaining that we were on a special mission to create one of the world's great companies—a business and ethical success. . . . I don't think any of those CEOs and companies were unethical, but they could not compare with SRA. I began to refer to them privately . . . as "sausage factories" that would grind up SRA and homogenize us into their system. Our name, values and culture would be lost forever. Many of those companies were quite successful, but I did not want SRA to become an Oscar Meyer [sic] wiener.
The record reflects that the idea to sell SRA was never seriously considered until a few years after the Company had begun to experience various problems. Since 2008, SRA had been experiencing declining growth rates, lower profit margins, and poorly performing acquisitions. As the Company's performance continued to falter in 2010,  Volgenau became interested in the prospect of a leveraged buy-out ("LBO"), which would, in theory, provide stockholders with a substantial premium to SRA's current stock price and afford Volgenau a better opportunity to preserve the Company's values and culture. But, as Volgenau acknowledged in his book, once he (and the Board) made the decision to sell SRA, the eventual acquirer might very well be a strategic competitor.
E. The Early Meetings with Providence
SEPTA asserts that Providence aided and abetted the SRA Directors' breach of fiduciary duty. In support of this theory, SEPTA points to Providence's retention of DiPentima, a former CEO of SRA, Volgenau's friend, and a paid consultant to SRA,  to exploit Volgenau's trust in DiPentima to effectuate a deal. Similarly, the Plaintiff contends that Ted Legasey ("Legasey"), also a former senior SRA executive and friend of Volgenau, was recruited to persuade Volgenau to sell the Company to Providence. In the spring of 2010, after an initial meeting between DiPentima and Volgenau, in which DiPentima raised the idea of an LBO,  Julie Richardson, the CEO of Providence, and other Providence employees began meeting with Volgenau and the senior management of SRA to discuss a possible buyout. These meetings involved preliminary discussions about the possibility of Volgenau's participating in the acquired company, indicative price points, and the importance of maintaining the value and culture of SRA. During this time Volgenau inquired about Providence's ability to obtain the necessary financing and whether a go-shop would disrupt the sale to Providence if an agreement could be reached. Providence provided research to Volgenau showing that it was highly unlikely that a topping bidder would emerge during the go-shop period. SRA shared proprietary information with Providence pursuant to a confidentiality agreement and SRA management developed various LBO scenarios. As discussions ensued, Volgenau was not only amenable to a transaction with Providence, but he also seemed to have significant interest in completing a deal with it.
F. The Study Team
At the same time as Volgenau was in discussions with Providence, on May 3, 2010, the Board formed a "study team" to assess the strategic alternatives for SRA. The study team included Volgenau, Klein, Gilburne, and Grafton. Notably, Klein encouraged Volgenau to exploit his particular interests as a controlling stockholder.
You are 77 years old. If you die or become incapacitated, your estate will no longer have the Class B (ten for one) voting shares, and the company's disposal will be unpredictable. Wouldn't you rather determine its future now, while you are in good health?
The study team hired CitiGroup to provide advice on strategic alternatives; it opined that a significant acquisition would best maximize the Company's long- term value because it would lead to "more technology and higher profits."
Consistent with that advice, SRA made a serious attempt to acquire Lockheed Martin's Enterprise Integration Group ("EIG") during the summer and fall of 2010. Although Volgenau supported SRA's attempted acquisition of EIG, he also had a desire to continue talks with Providence, even though the acquisition would either postpone or preclude any deal with Providence. Legasey, on behalf of Providence, tried to persuade Volgenau not to pursue the EIG acquisition and warned that Providence would no longer be interested in acquiring SRA.Nonetheless, SRA proceeded with its bid, but ultimately lost out to Veritas Capital ("Veritas"), which purchased the EIG unit for $815 million.
G. The Formation of the Special Committee and Other Indications of Interest
Following the failed EIG bid, Volgenau and the Board turned its attention again to Providence. During an October 27, 2010, study team meeting, Volgenau indicated that Providence was the only potential bidder that had ever interested him and that it was committed to maintain the Company's values and culture. With Volgenau's tacit endorsement of Providence, Klein suggested that the Board form an independent special committee, which it did the following day (the "Special Committee"). The Special Committee, which was comprised of Klein, as chair, along with Gilburne, Grafton, Barter, and Ellis,  was charged with evaluating, soliciting third-party interest in, and negotiating potential strategic transactions.The Special Committee's mandate also included an express authorization to hire its own advisors.
The Special Committee hired a financial advisor, Houlihan Lokey Capital, Inc. ("Houlihan"), and legal counsel, Kirkland & Ellis LLP ("Kirkland"), to assist it in its evaluation of potential strategic transactions. SEPTA asserts that both Houlihan and Kirkland were hired because of their prior professional and personal relationships with Klein. According to Klein, they were selected because they had no prior experience with SRA and they were well qualified. Volgenau was also instructed that he should not have "any further discussions with Providence [or any other bidder] except as may be approved and coordinated by the Committee . . . ."
On November 22, 2010, Houlihan and Klein met with representatives from Providence. During the meeting Klein informed Providence that SRA had decided not to undertake a formal sale process and that Providence's initial $28 per share expression of interest was insufficient to start formal discussions. On behalf of the Special Committee, Klein also rejected Providence's request for exclusivity, but permitted it to conduct further due diligence.
As the Special Committee awaited Providence's formal bid, on December 1, 2010, Serco, a strategic competitor, proposed a transaction at a higher price range ($29-$31 per share) than Providence's initial indication of interest. In an email dated December 9, 2010, Klein advised Providence of the superior offer, but noted that "Ernst has fended off numerous interested parties over the past years and had every intention to continue to do that while we await your proposal." Klein testified that his email was intended to elicit a higher offer from Providence that would start the process at $30 per share or more. However, on December 29, 2010, Providence submitted a bid of $27.25 per share.
Not surprisingly, the Special Committee viewed Providence's preliminary expression of interest as insufficient to start the negotiation process with Providence. Consequently, the Special Committee determined that "it was appropriate to explore and assess additional third-party interest . . . in a potential strategic transaction with the Company." Accordingly, in early January 2011, the Special Committee decided to solicit five financial buyers: The Carlyle Group ("Carlyle"), TPG Capital ("TPG"), Kohlberg Kravis & Roberts (KKR"), Veritas and Bain Capital ("Bain"), as well as continue discussions with Serco. A sixth financial sponsor—Hellman & Friedman—was later added to the mix. Although the Board was generally aware that strategic acquirers in theory had the potential to pay more for SRA,  Grafton testified that the reason that the Special Committee declined initially to solicit other strategic acquirers was in order to safeguard confidential and proprietary information and avoid "leaks into the marketplace."
By mid-January, however, the markets began to speculate that SRA had received acquisition proposals. After Sloane cancelled his appearance at a January 6 investor conference, SRA's stock price rose 19 percent in one week based on rumors that SRA was for sale. Moreover, word leaked erroneously that Serco had submitted, and SRA had rejected, a $2 billion offer to buy SRA. As a result of the ensuing publicity, much of which was negative,  Serco withdrew its preliminary offer and terminated discussions with SRA.
On January 25, 2011, SRA confirmed publicly that it had received "a series of inquiries regarding the company's willingness to consider offers" and therefore, SRA had retained Houlihan to provide advice. Although the press release cautioned that "the retention of advisors does not reflect a decision that the company is or should be for sale, " by then it was clear that SRA was entertaining acquisition offers.
In light of the newfound publicity and the ensuing expressions of interest, the Special Committee sought to open up the bidding process to other strategic sponsors to extract the maximum possible value for SRA. To his credit, Volgenau consented. To address Volgenau's concerns, however, the Special Committee established a bifurcated process in which it would exclusively address issues of price and certainty while Volgenau would meet with strategic acquirers to discuss his "humanistic concerns." Thus, in February and early March, Volgenau met alone with strategic and financial sponsors to learn more about them and to discuss his desire that "SRA's name, values and culture be preserved."
On February 4, 2011, Houlihan contacted three other strategic bidders: The Boeing Company ("Boeing"), CGI, and Hewlett Packard ("HP"), and one additional financial buyer: GTCR LLC ("GTCR"). Another strategic bidder— L-3 Communications Holdings, Inc. ("L-3")—also contacted Houlihan to express interest in a potential transaction. During the due diligence process, strategic and financial sponsors signed confidentiality agreements and conducted due diligence on SRA—which included access to a confidential data room and meetings with the senior management of SRA. Ultimately, for various reasons, all but two of the potential bidders chose either not to join the sale process or to submit a formal offer for the Company.
H. The Multi-Round Bidding Contest Between Veritas & Providence
With all of the remaining suitors having dropped out of the bidding process, Veritas and Providence became engaged in a multi-round bidding contest. On March 18, 2011, Providence submitted an offer to purchase SRA for $30 per share. Two days later, Veritas made a written offer for the same amount, but conditioned it on Volgenau's increasing his rollover amount from $100 million to $150 million. Volgenau agreed to do so. He also agreed to the same rollover amount for Providence, if it desired.
By March 30, the $30 per share deadlock was broken when Veritas improved its offer to $31 per share and Providence increased its offer to $30.50. However, on the evening of March 30, 2011, Providence made two new proposals to increase its bid to $31 per share or higher. First, Providence made an offer "consisting of $30.50 plus a contingent amount equal to the proceeds (if any) received from the sales of two of the Company's subsidiaries, [Era Systems LLC ("Era")] and [Global Clinical Development ("GCD")], [both of which were] currently being marketed." Second and alternatively, Providence offered to increase the purchase price to $31 per share if Volgenau would "agree as part of his [$150 million] rollover commitment to provide a $30 million non-recourse loan to Providence, which loan would be repaid" only if the Company realized sufficient proceeds from the sale of the two subsidiaries being marketed.Importantly, with respect to the second proposal, the Special Committee concluded that Volgenau would not be receiving "any additional economic benefit under the loan if the proceeds of such subsidiary sales were to ...