Date Submitted: November 14, 2013
Jessica Zeldin, Esquire of Rosenthal, Monhait & Goddess, P.A., Wilmington, Delaware, and Carl L. Stine, Esquire of Wolf Popper LLP, New York, New York, Attorneys for Plaintiff.
Kenneth J. Nachbar, Esquire, Jay N. Moffitt, Esquire, Shannon E. German, Esquire, and Lindsay M. Kwoka, Esquire of Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware; Joel G. Chefitz, Esquire of McDermott Will & Emery, Chicago, Illinois; and Michael R. Huttenlocher, Esquire of McDermott Will & Emery, New York, New York, Attorneys for Defendants.
NOBLE, Vice Chancellor
Plaintiff Richard Frank ("Frank") brings claims against the board (the "Board") and two key employees of Defendant American Surgical Holdings, Inc. ("American Surgical") in the context of American Surgical's merger (the "Merger") with an affiliate of Great Point Partners I, LP (together with AH Holdings Inc. and AH Merger Sub, Inc., "GPP"). In the Merger, which was the culmination of a market canvass to sell the company in response to an unsolicited expression of interest by GPP, some stockholders who together held a majority of American Surgical's stock (the "Rollover Group") received a combination of cash and equity in the surviving entity, while the other stockholders received only cash.
Frank alleges that the Rollover Group breached its fiduciary duties by "foisting an unfair transaction, both in terms of process and price, " upon the other stockholders. This unfair transaction allegedly deprived these minority stockholders of the "true value inherent in and arising from American Surgical."Substantially identical allegations underlie Frank's claim for unjust enrichment against the Rollover Group. In addition, Frank alleges that Defendants Zak W. Elgamal ("Elgamal"), Jaime Olmo-Rivas ("Olmo-Rivas"), Charles Bailey ("Bailey"), Michael Kleinman ("Kleinman"), Henry Y.L. Toh ("Toh"), Bland E. Chamberlain III ("Chamberlain") and Jose Chapa Jr. ("Chapa, " and collectively, with American Surgical, the "Defendants") breached their fiduciary duties to the stockholders of American Surgical under three primary theories: (i) by failing to maximize stockholder value in the sale of the company; (ii) by approving a transaction at a purportedly unfair price after a sale process dictated by the Rollover Group; and (iii) by failing to disclose material information in the proxy statement for the stockholder vote on the Merger.
Pursuant to Court of Chancery Rule 56, the Defendants have moved for summary judgment on Frank's remaining claims (the "Motion"). The Motion implicates two primary questions: first, whether the Merger, in whole or in part, should be subject to the entire fairness standard of review; and second, whether the conduct of a special committee of the Board (the "Special Committee") should shift the burden of proof of entire fairness to Frank.
For the following reasons, the Court is unable to conclude whether the allocation of the consideration paid to the Rollover Group and the minority stockholders in the Merger is subject to the entire fairness standard of review. Issues of material fact remain as to whether the Rollover Group was a control group that dictated certain aspects of the negotiations with GPP or that competed with American Surgical's minority stockholders for the consideration paid by GPP. Likewise, assuming the entire fairness standard applies, the Court is unable to conclude if the burden of proof should shift to Frank because issues of material fact remain as to whether the Special Committee was well functioning and fully informed about the material negotiations with GPP over the allocation of the consideration in the Merger.
Separately, the Court concludes that certain defendants are entitled to summary judgment in their favor on certain aspects of Frank's breach of fiduciary duty claim asserted against them. There is no genuine issue of fact that these individuals either did not owe fiduciary duties to the corporation and its stockholders or did not breach their duty of loyalty or act in bad faith by selecting GPP as the highest bidder after the market canvass or by agreeing to the Merger. The Court cannot grant summary judgment as to other aspects of the breach of fiduciary duty claim because there is a possibility that the entire fairness standard may apply.
For these and other reasons set forth below, the Motion is granted in part and denied in part.
II. THE PARTIES
American Surgical was a Delaware corporation headquartered in Houston, Texas. It provided "surgical assistant services to patients, surgeons, and healthcare institutions" in metropolitan areas in Texas, Oklahoma, Virginia, Tennessee, and Georgia. American Surgical's charter included an exculpatory provision for potential monetary liability of its directors under 8 Del. C. § 102(b)(7) (the "Exculpatory Provision"). Frank was a stockholder of American Surgical until the Merger closed on March 23, 2011.
Elgamal, Olmo-Rivas, Bailey, Kleinman, and Toh comprised the Board of American Surgical. Elgamal and Olmo-Rivas formed the company in 1999,  and it went public in March 2007, trading on the OTC Bulletin Board. Elgamal was American Surgical's President and Chief Executive Officer; Olmo-Rivas was also an executive officer.
Each of Bailey, Kleinman, and Toh joined the Board in 2007. Bailey has a law degree and has significant experience as a surgeon. Kleinman is a board-certified surgeon and a clinical professor at two prominent universities. Elgamal invited these two doctors to be directors because of their positive working relationships with American Surgical, likely stemming from their use of the company's surgical assistants in their practices. Bailey, for one, was friends with Elgamal and had even used Elgamal and Olmo-Rivas personally as surgical assistants.
Toh was recommended to serve on the Board by Dawson James Securities, Inc. ("Dawson James"), an investment brokerage firm that held a large amount of American Surgical's debt. He had served as a director of several companies and was also designated American Surgical's lead independent director and financial expert. Toh did not have a personal relationship with anyone in the Rollover Group prior to joining the Board, and his professional relationship with Elgamal and Olmo-Rivas away from the company before the Merger was limited to receiving, in exchange for serving as an interpreter, a five percent interest in a company founded by Elgamal and Olmo-Rivas that he claimed "never went anywhere."
During the time period at issue in this action, the Board would form first a mergers and acquisitions committee (the "M&A Committee") and then the Special Committee. Elgamal, Olmo-Rivas, and Toh comprised the M&A Committee. Bailey and Kleinman comprised the Special Committee.
Chamberlain and Chapa were surgical assistants employed by American Surgical. They started working for the company, respectively, after it purchased Regional Surgical Assistants, Inc., from Chapa in 2005 and Katy Surgical Assistants, Inc., from Chamberlain in 2006. Chamberlain and Chapa were neither directors nor officers of American Surgical, but they were designated as "key employees" in the company's filings with the Securities and Exchange Commission ("SEC").
Elgamal, Olmo-Rivas, Chamberlain, and Chapa are the members of the Rollover Group. They were American Surgical's four largest stockholders before the Merger: Elgamal beneficially owned 27.53% of the company's common stock; Olmo-Rivas beneficially owned 27.58%; and Chamberlain and Chapa each beneficially owned 8.04%. Excluding options and stock held by their families, the members of the Rollover Group held 68.42% of American Surgical's stock at the time of the Merger, with Elgamal and Olmo-Rivas holding over 50%.
A. American Surgical's Financial Performance in 2009
American Surgical's business model was relatively straightforward: its surgical assistants would perform medical procedures, and the company would bill the patient's insurance company. The overwhelming majority of the company's revenue was generated through procedures involving patients covered by private insurance. In 2007, only a handful of states required insurance companies to reimburse surgical assistants; accordingly, the company's national growth prospects were fairly limited.
From summer 2007 until early 2009, the company was suffering from negative cash flow, primarily because some insurers were not reimbursing the company for services already provided by its surgical assistants. To compound this problem, Dawson James indicated its intent to foreclose on an American Surgical note in excess of $2 million that had become due around this time.
By mid-2009, American Surgical's financial outlook had improved. The company made budget cuts, filed lawsuits to recover outstanding insurance claims, and entered into agreements with certain third-party administrators to improve collection rates. And, Toh was able to negotiate more favorable terms with Dawson James on the outstanding note. Others-including GPP, a private equity firm with several portfolio companies in the medical industry-took notice of this improved performance.
B. GPP First Expresses Interest in a Transaction with American Surgical
In June 2009, a GPP representative cold-called Elgamal to see if he was interested in talking with GPP about its interest in "buying the company." After dismissing the GPP representative's overtures more than once, Elgamal referred him to Jim Longaker ("Longaker"), the company's Chief Financial Officer ("CFO"). The GPP representative again expressed interest to Longaker about a possible transaction between his firm and American Surgical, and Longaker relayed this information to Elgamal.
C. The Board Responds to GPP's Interest by Forming the M&A Committee
Eventually, the Board was notified about GPP's expression of interest. Then, the Board considered its options and, according to Elgamal, "agreed on the concept of putting the company up for sale." Several reasons motivated their thinking that it might be an opportune time in general to sell American Surgical. First, the directors expected that the company would be an attractive target because of its recent financial performance. Second, Elgamal and Olmo-Rivas were approaching retirement and looking for an "exit strategy." Third, the Board was uncertain about the company's future in light of upcoming federal healthcare legislation-namely, the Patient Protection and Affordable Care Act. Because American Surgical was not reimbursed for providing surgical assistants to patients covered by Medicare and Medicaid, the expected enrollment increase for these federal programs by virtue of healthcare reform legislation was perceived as a threat to the company's future revenue. Bailey could not recall exactly when the concept of putting the company up for sale was agreed upon, but he nonetheless thought it was "a rational thing to consider."
The directors soon had informal discussions in late June or July 2009 about forming a committee to take charge, at least initially, of this project. Elgamal, Olmo-Rivas, and Toh were the focus of who would serve on the M&A Committee, which would quickly begin a process to canvass the market for potential acquirers of American Surgical. Elgamal and Olmo-Rivas asked Toh to find a financial advisor; Toh recommended Marshall Webb ("Webb") of Polaris Group ("Polaris").
In Toh's opinion, Webb was the right advisor at the right price. Toh understood that Webb had "immense public company experiences, " particularly with companies similar to American Surgical. Although he did not know anyone in the Rollover Group, Webb described his focus at Polaris as providing financial advisory services to the "staffing and healthcare services industry." After meeting with Webb, the M&A Committee found him "credible" and then "agreed on hiring him" as the company's financial advisor.
On July 10, 2009, American Surgical formally engaged Polaris to provide certain sell-side advisory services. Specifically, Polaris would "identify and qualify select potential acquirers of One-Hundred Percent (100%), or subject to the final decision of Messrs. Elgamal and Olmo[-Rivas], a controlling equity interest, of [American Surgical]." Webb would receive $7, 500 as an advisory fee plus reimbursement of reasonable expenses. Elgamal anticipated that Webb's primary assignment would be to find "a credible potential acquirer to buy the company."
More than a month after hiring Webb, on August 12, 2009, the Board formally ratified the formation of the M&A Committee "for the purpose of pursuing business opportunities" for the company. The Board also formally appointed Polaris as the financial advisor to the M&A Committee.
D. Webb's Market Canvass Yields Three, Serious Indications of Interest
Webb began to compile a list of "qualified acquirer[s]" that would "potentially have interest in American Surgical." By October 2009, Polaris had distributed blind summaries to thirty-five possible acquirers.
Potential acquirers, including private equity firms such as GPP, began preliminary discussions with Webb. In the midst of this process, Elgamal and Olmo-Rivas noted to Webb and Toh that, were there to be a merger, they would be open to rolling over a portion, between 20-30%, of their American Surgical stock into equity in the surviving entity. It was framed as a "no less than 70% up front" condition. Both individuals also expressed their unwillingness to rollover any equity without a sufficient employment package with the surviving entity.
Based on a representative's initial conversation with Longaker, GPP expected that members of management would want to cash out their entire interest in American Surgical in any transaction. But, after a meeting with various members of the Rollover Group, a GPP representative noted in an internal email that "the owners mentioned their desire to roll 30% into Newco." In a separate internal email in January 2010, a GPP representative would describe the firm's "strong preference" for a 30% rollover "by all the key management members."As a member of the GPP deal team testified, his position was for the company's management "to have a meaningful rollover into Newco, " while the Rollover Group was only "willing to roll enough to get the deal done."
Over twenty entities contacted by Webb indicated varying levels of positive responses. Before the end of the year, the company received non-binding indications of interest from three potential acquirers: (i) Celerity Partners ("Celerity") on November 16; (ii) GPP on October 6, with financial terms provided on November 25; and (iii) Nurses in Partnership ("NIP") on December 15.
The financial terms of the three letters varied. Celerity contemplated purchasing 100% of the stock held by the Rollover Group for $26.1 million.GPP proposed to acquire American Surgical through a merger in which the company's largest stockholders-the Rollover Group plus Longaker and Toh- would receive $2.065 in cash per share and $0.885 in stock in the surviving entity per share and the minority stockholders would receive $2.95 in cash per share. This ratio reflected an effective 30% rollover for an approximately 21% interest in the surviving entity. Finally, NIP proposed to acquire 65% of the company's fully diluted shares for $15.6 million, with $7 million paid in cash and $8.6 million paid in a note over 36 months. NIP's offer implied an enterprise value of $24 million, which was the lowest of the three indications of interest.
The M&A Committee delegated primary responsibility for responding to potential acquirers and preliminary due diligence requests to Toh and Webb.Less than a week after its first letter, Celerity submitted a second indication of interest that implied an enterprise value of $27.5 million. It contemplated, after reimbursement of transaction fees, a preferred stock issue for 70% of the company to Celerity with current American Surgical stockholders receiving a pro-rata portion of a $22 million dividend, financed by cash and debt, and retaining a 30% equity interest in the company.
E. The Board Forms the Special Committee to Take Over the Sale Process
1. The Special Committee's Purpose
In the midst of receiving these indications of interest, on December 2, 2009, the Board held a meeting and deemed it in "the best interests of all shareholders, especially the minority shareholders, " to form the Special Committee of independent directors "to carry out the duty of care and loyalty, in the evaluation of these potential offers, in order to maximize shareholders value." At Toh's nomination, Bailey and Kleinman comprised the Special Committee. Elgamal in particular "wanted independent directors to be involved [in the sale process] . . . to make sure that the interest of the minority shareholders is taken care of" in any possible transaction. Although he was initially considered, Toh declined to serve on the Special Committee, presumably due to Dawson James's recommending him to the Board, because he "felt there should be zero conflict of interest."
Bailey understood his role on the Special Committee as "protecting the minority shareholders." He believed that he and Kleinman should "look at everything . . . from the viewpoint of how it would impact the minority shareholders . . . and act in their best interest." At the time, there was no particular discussion about whether the sale of American Surgical would create a conflict between the Rollover Group, particularly Elgamal and Olmo-Rivas, and the company's minority stockholders.
On December 10, 2009, after a presentation by Toh on the qualifications of the law firms bidding on the engagement, the Special Committee retained Robert Viguet ("Viguet") from Thompson & Knight LLP as its legal advisor. Bailey considered the firm well-respected and appreciated that Viguet personally "had done a lot of this type of work in the past." At the next Special Committee meeting on December 12, Viguet informed Bailey and Kleinman about "the rules that exist for the protection of minority shareholders, " especially "the function of special committees." The minutes reflect additional discussion about this topic.
2. The Special Committee's Role in Negotiations
The Special Committee, Bailey and Kleinman, did not directly negotiate with any potential acquirer, including GPP. At his deposition, Bailey conceded that he considered mergers and acquisitions as "out of [his] area of expertise."The process adopted, from Bailey's perspective, was that the Special Committee would "monitor negotiations" conducted by others on its behalf-primarily Toh, Webb, and Viguet-and then "send instructions back" with an eye toward discharging its "duty to not go along" with "anything that looks like it's harmful to the minority stockholders." Bailey personally viewed Webb not so much as an advisor but rather as someone who kept the Special Committee "informed."
At their depositions, Webb and Toh agreed with this description of the overall negotiation process. Toh explained the procedure as "[t]he M&A committee, through me, at the direction of the special committee[, ] negotiated directly with [potential acquirers] through me and Marshall [Webb]." When possible, Toh consciously structured the negotiations in a way that would avoid any direct contact between the Special Committee and any potential acquirer.
The Special Committee held six meetings after its formation in December 2009 through January 2010. During this period, the Special Committee generally did not review the specific actions taken by the M&A Committee, such as the market canvass conducted by Webb. On December 16, 2009, Webb presented to the Special Committee a summary of the indications of interest from Celerity, GPP, and NIP. Based on his past experiences, Bailey was most interested in a transaction that would yield all cash, instead of a mix of cash and equity in the surviving entity, for American Surgical's minority stockholders. The Special Committee directed Webb and Toh to continue to negotiate with all three potential acquirers.
F. Negotiations Continue with the Three Potential Acquirers
1. NIP Soon Drops from Contention
On January 10, 2010, NIP submitted a revised, non-binding letter of intent on the same financial terms-acquiring 65% of the company's fully diluted stock for $15.6 million-as its earlier letter. The Special Committee found many terms in the NIP offer, including this price, to be "not attractive." Webb also found the NIP offer to be "unrealistic" such that no one seriously viewed NIP as a "contender." It does not appear that the Special Committee requested any further negotiations with NIP after this revised letter.
2. Competing Offers by Celerity and GPP
Based on continuing negotiations and due diligence, Celerity submitted a third, non-binding indication of interest on January 12 (the "Third Celerity Letter"). The proposal implied an enterprise value of $46 million "based on a 4.6x multiple of approximately $10.0 million of 2009 adjusted EBITDA." It provided for Celerity to receive 70% of the equity of American Surgical and reimbursement of its transaction fees, with current stockholders receiving a pro-rata portion of a $39, 075, 000 dividend, financed by cash and debt, and retaining a 30% equity interest in the company. The Third Celerity Letter also contemplated a termination fee of $1.84 million.
GPP submitted its own revised letter of intent on January 15 (the "Second GPP Letter"). The consideration contemplated was largely similar to GPP's previous letter, with the minority stockholders of American Surgical to receive $2.95 in cash per share and a select group of stockholders-now the Rollover Group plus only Longaker-to receive $2.065 in cash per share and a pro-rata portion of a 21% equity interest in the new subsidiary of GPP. The Second GPP Letter capped each of the transaction reimbursement and termination fees at $500, 000, and it included a fiduciary out that would appear in every subsequent proposal by GPP. Further, it proposed the "key terms of employment" for Elgamal and Olmo-Rivas.
The Special Committee and its advisors considered the Third Celerity Letter and the Second GPP Letter at a meeting on January 15, 2010. The employment terms for Elgamal and Olmo-Rivas of the Second GPP Letter were described as "a condition to the proposed acquisition." Webb and Toh reported on their discussions with Elgamal and Olmo-Rivas about "their requirements as to compensation in order to continue as officers and employees of the Company, " and both individuals had "indicated that they would" accept the key employment terms proposed. Webb viewed the Second GPP Letter as "much more attractive to the Company than any of the other offers, " but he nonetheless thought he could negotiate a higher offer from Celerity. The Special Committee directed him to obtain the "highest and best offer for the sale of the Company" from Celerity and GPP.
3. The Highest and Best Offers
Webb was not successful in negotiating an all-cash offer from Celerity for the minority stockholders of American Surgical. Celerity did submit a fourth letter of intent, but its financial terms did not differ materially from those of the Third Celerity Letter and the implied enterprise value of $46 million. By contrast, Webb's efforts with GPP were more fruitful. A week after the Second GPP Letter, GPP submitted another revised letter of intent on January 22 (the "Third GPP Letter"). At an enterprise of approximately $47.5 million, the Third GPP Letter provided for the minority stockholders to receive $3.1655 in cash per share and for the Rollover Group plus Longaker to receive $2.2158 in cash per share and approximately 21% ownership of the surviving entity. Once again, these terms assumed an effective 30% rollover by the Rollover Group and Longaker. The Third GPP Letter further contemplated a forty-five day exclusivity period, but it still included a fiduciary exception for the Board to consider a superior proposal.
4. Contemporaneous Actions by the Board
Around this time, the Special Committee determined that, because outstanding options would vest upon a transaction and thus reduce the per-share consideration received by American Surgical stockholders, it was in the interest of all stockholders to reduce the number of outstanding options. At a January 21 meeting, the company's compensation committee, comprised of Bailey and Kleinman, decided to offer cash bonuses totaling $562, 500 to Board members in exchange for their cancelling of 625, 000 options for American Surgical stock (the "Option Exchange"). At an average strike price of $2.20, the consideration was approximately $0.90 per option. Through the Option Exchange, Elgamal and Olmo-Rivas received $225, 000 each; Toh received $67, 500; and Bailey and Kleinman received $22, 500 each.
G. The Special Committee Accepts the Third GPP Letter
During a meeting on January 23, 2010, the Special Committee considered, for a final time, the highest and best proposals from Celerity and GPP. At this time, the Special Committee does not appear to have requested or received financial projections from management. Webb considered these proposals from Celerity and GPP to be "the most favorable offer that he believed could be obtained from the potential purchasers." When asked directly by the Special Committee which proposal was more favorable to the company's minority stockholders, Webb described the Third GPP Letter as representing "the best overall proposal for shareholders of the Company." Based on Webb's comments and additional analysis by Toh and Viguet, the Special Committee voted to accept the terms of the Third GPP Letter. The Board then unanimously accepted the recommendation of the Special Committee on January 25.
H. GPP Revises the Financial Terms of its Proposal
As GPP conducted further due diligence of American Surgical, a material dispute arose. The company was notified in late February 2010 about a quality of earnings report by KPMG, GPP's due diligence advisor, raising an objection to certain aspects of the company's revenue for 2009. In brief, American Surgical recognized $2.7 million in revenue in 2009 for surgical assistant services provided in 2008. KPMG took the position that, even though this revenue recognition was not improper under generally accepted accounting principles, it artificially inflated American Surgical's 2009 revenue, and thus GPP's valuation of the company.Based on this and other objections, KPMG recommended revising the company's 2009 EBITDA from $10.5 million to $7.1 million.
Consequently, GPP wanted to revise the terms of the Third GPP Letter. In an early March 2010 diligence presentation, GPP expressed its interest to Toh and Webb in reducing the consideration to be received from $3.166 in cash per share for American Surgical's minority stockholders and $2.216 in cash per share and approximately 21% ownership of the surviving entity for the Rollover Group plus Longaker to $2.532 in cash per share for the minority stockholders and $1.773 in cash per share and 21.4% of the surviving entity for the Rollover Group and Longaker.
Sometime during March 9 or March 10, representatives of GPP met with Toh and Webb to negotiate revised financial terms. After the meeting, GPP thought it had "reached a revised deal" at $2.86 per share. The next day, Webb circulated by email to Elgamal, Olmo-Rivas, and Toh his recollection of three options (the "Three Options") discussed with GPP,  although that GPP representative testified at his deposition that he could not recall specifically discussing "this array" of particular options at that meeting. The Three Options differed in the amount of cash and equity in the surviving entity to be received by the Rollover Group, now without Longaker, and the per-share cash consideration to be received by American Surgical's minority stockholders.
On one side of the scale, the "First Option" provided that the Rollover Group would receive $2.217 in cash per share and a 16.06% interest in the surviving entity, with the minority stockholders receiving $2.86 in cash per share. On the other side, the "Third Option" provided that the Rollover Group would receive $2.103 in cash per share and a 19.62% interest in the surviving entity, with other stockholders receiving $2.90 in cash per ...