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In re Crimson Exploration Inc.

Court of Chancery of Delaware

October 24, 2014

IN RE: CRIMSON EXPLORATION INC. STOCKHOLDER LITIGATION Case Posture Share % Controller?

Submitted: February 25, 2014

Carmella P. Keener, Esq., ROSENTHAL, MONHAIT & GODDESS, P.A., Wilmington, Delaware

Seth D. Rigrodsky, Esq., Brian D. Long, Esq., Gina M. Serra, Esq., RIGRODSKY & LONG, P.A., Wilmington, Delaware

Kent A. Bronson, Esq., Andrei V. Rado, Esq., Gloria Kui Melwani, Esq., Melissa Ryan Clark, Esq., MILBERG LLP, New York, New York; James S. Notis, Esq., Kira German, Esq., GARDY & NOTIS, LLP, New York, New York; Attorneys for Plaintiffs.

Srinivas M. Raju, Esq., Robert L. Burns, Esq., RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware

Michael C. Holmes, Esq., Elizabeth C. Brandon, Esq., VINSON & ELKINS LLP, Dallas, Texas.; Attorneys for Defendants Crimson Exploration Inc., Thomas H. Atkins, Lee B. Backsen, B. James Ford, E. Joseph Grady, Anthony C. Isaac, Allan D. Keel, Lon McCain, Jay S. Mengle, Adam C Pierce, John A. Thomas, Cassidy J. Traub, Ni Zhaoxing, Oaktree Capital Management, L.P., OCM GW Holdings, LLC, and OCM Crimson Holdings, LLC.

MEMORANDUM OPINION

PARSONS, VICE CHANCELLOR.

The plaintiffs in this consolidated class action challenge the now-completed stock-for-stock merger of Crimson Exploration, Inc., and Contango Oil & Gas Co. (the "Merger"). The plaintiffs allege that the directors of Crimson breached their fiduciary duties in approving the Merger. Their claims challenge the Merger on the familiar grounds of inadequate process, inadequate price, and inadequate disclosure. The complaint also alleges that a group of affiliated defendants, including Oaktree Capital Management, L.P., constituted controlling stockholders of Crimson and breached their fiduciary duties by selling the company below market value for self-serving reasons. As such, the plaintiffs ask the Court to review the challenged transaction under the entire fairness standard. Finally, the plaintiffs accuse Contango, and its affiliate, Contango Acquisition, Inc., of aiding and abetting the foregoing breaches of fiduciary duties.

For the reasons that follow, the Court concludes that the complaint must be dismissed under Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief can be granted. Even if the plaintiffs properly allege that Oaktree, alone or with others, occupies the position of a controller that owes fiduciary duties to the other stockholders, the well-pled allegations are insufficient to implicate entire fairness. As to the director defendants, the plaintiffs failed to allege sufficient facts to support a reasonable inference that a majority of the Board was not disinterested or lacked independence. Thus, no claims against the directors support use of the entire fairness standard. Reviewing the allegations of wrongdoing under the business judgment rule, the Court finds them insufficient to state a claim. The aiding and abetting claims must be dismissed as well largely because, apart from the inadequately pled breaches of fiduciary duty in Counts I and II, nothing remains for Contango or its affiliates to have aided or abetted.

Lastly, the Court denies a pending motion to intervene and finds that the proposed intervenor has not proffered any additional information so material that it would be unjust to dismiss this complaint with prejudice.

I. BACKGROUND [1]

A. The Parties

Defendant Contango Oil & Gas Co. ("Contango"), a Delaware corporation headquartered in Houston, Texas, is an independent natural gas and oil company that focuses primarily on properties in the Gulf of Mexico. Contango is the acquiring company in the Merger.

Crimson Exploration, Inc. ("Crimson" or the "Company") is a Delaware corporation headquartered in Houston, Texas, that operates as an independent oil and gas company. It focuses primarily on the Gulf Coast, Texas, and Colorado regions. Crimson's board consists of seven individuals, each of whom is a named defendant in this action. Crimson became a subsidiary of Contango following the Merger.

Oaktree Capital Management, L.P. ("Oaktree Capital") is an investment management firm. OCM Crimson Holdings LLC ("OCM Crimson") is a Delaware limited liability company ("LLC") and an Oaktree Capital affiliate. OCM GW Holdings, LLC ("OCM Holdings") is also a Delaware LLC. OCM Holdings is the holding company for Oaktree Capital, OCM Crimson, and other unspecified Oaktree affiliates (collectively, the "Oaktree Entities").[2] Oaktree holds roughly 15.5 million shares of Crimson common stock, which represents about 33.7% of its outstanding shares. An Oaktree affiliate also owns a significant, though unspecified, portion of Crimson's $175 million Second Lien Credit Agreement ("Second Lien"). Plaintiffs allege that Oaktree is Crimson's controlling stockholder.

Allan D. Keel is Crimson's President and CEO. He is also a member of the board. Keel owned slightly more than one million shares of Crimson common stock. He signed a support agreement to vote his shares in favor of the Merger. Following the Merger, Keel became the President and CEO of the surviving corporation and remained a director.

B. James Ford has been a director of Crimson since February 28, 2005. He is the Co-Portfolio Manager and Managing Director of Oaktree Capital Group LLC ("Oaktree Group"), Oaktree Capital's successor. He owns no shares of Crimson stock, but does own slightly more than 1.4 million shares, or slightly less than 1%, of Oaktree Group stock valued at $77 million. As anticipated, Ford has served as a director on the board of the combined company following the Merger.

Cassidy J. Traub became a Crimson director on December 7, 2009, and served on the board until the Merger closed. He also is a Vice President at Oaktree Management's Principal Group and has worked for Oaktree since 2005. He owned no Crimson stock.

Adam C. Pierce was a member of the Crimson board from January 24, 2008, until the Merger closed. He is a Senior Vice President of Oaktree, but he personally owned no Crimson stock.

Lon McCain has been a Crimson director since June 1, 2005. He has served on the board of directors of the surviving company since the Merger was effectuated.

Ni Zhaoxing served on the Crimson board as a director from December 22, 2010, until the Merger closed. He is the Chairman and CEO of America Capital Energy Corporation (ACEC). ACEC owned over 6.6 million shares of Crimson common stock, roughly 14.9% of all shares outstanding. ACEC is wholly owned by Shanghai Zhong Rong Property Group, Ltd. ("SZRPG"). Ni is the founder, CEO, and controlling stockholder of SZRPG. Plaintiffs allege that Ni, in effect, controlled ACEC's shares of Crimson. In addition, ACEC was a permitted investor under Crimson's Second Lien.

The seventh director of Crimson, Lee B. Backsen, assumed that post on June 1, 2005, and held it until the Merger closed.[3]

Defendant Contango Acquisition, Inc. (the "Merger Sub"), along with Contango, is accused of aiding and abetting. "Defendants, " therefore, consist of the Merger Sub, Contango, the Director Defendants, the Oaktree Entities, and Crimson.

The lead plaintiffs John Knapp, Theodore Schumm, and James P. Hoffmann ("Plaintiffs") initiated this consolidated class action. Collectively, they held at all relevant times over 228, 000 shares of Crimson common stock. Plaintiffs filed the operative Complaint on September 13, 2013.

B. Significant Non-Parties

The Complaint highlights the roles of certain members of Crimson's management team and emphasizes the degree of continuity between those executives and managers before and after the Merger. For example, E. Joseph Grady, Crimson's Senior Vice President and CFO, will become the Senior Vice President and CFO of Contango. As of the Merger date, Grady held slightly more than one-half million shares of Crimson. Along with Keel, Grady participated extensively in the Merger negotiations.

Several other members of the Crimson management team also continued to serve as part of Contango's management. Thomas H. Atkins, Crimson's Senior Vice President of Exploration, held about one-quarter million shares of Crimson and became Senior Vice President of Exploration of the combined company. A. Carl Isaac, Crimson's Senior Vice President of Operations, held nearly one-fifth of a million shares of Crimson, and stayed on as Vice President of Operations. Jay S. Mengle, Crimson's Senior Vice President of Engineering, held more than one-third of a million shares of Crimson stock and has served as the Senior Vice President of Engineering of the combined company. Finally, John A. Thomas, General Counsel and Corporate Secretary of Crimson before the Merger, owned 37, 000 shares of Crimson stock.

Each of these executives entered into support agreements to vote their shares in favor of the Merger.

C. Facts

1. Crimson Exploration: Its history, operations, and balance sheet

Crimson traces its history back to 1987. By May 2001, the Company was known as GulfWest. In late 2004 and early 2005, Keel saw an opportunity in the then-struggling and cash-strapped GulfWest. Seeking investors to provide the capital needed to get the Company back on track, Keel contacted Oaktree. Though Keel initially intended to take GulfWest private, Oaktree decided to leave the Company public and invested $40 million in February 2005. In connection with that recapitalization, Keel received a substantial portion of the Company's equity pursuant to an agreement he had with Oaktree, and he joined GulfWest as CEO. Around the same time, Grady became the CFO. On June 29, 2005, GulfWest merged with and into Crimson Exploration, Inc., thus becoming a Delaware corporation and acquiring a new moniker.

Initially, natural gas dominated Crimson's production profile. By 2012, however, natural gas liquids and crude oil each comprised roughly half of its production profile. Without delving into the same level of detail as the Complaint in describing Crimson's energy assets, I note two specific oil leaseholds. The first one, the Woodbine oil plays in Southeast Texas, allegedly constitute important, long-term, oil-producing properties that will generate above-average returns. Crimson acquired the Woodbine leaseholds in 2011 and reported successful drilling there in 2012. The second leasehold is the Buda formation in South Texas. It is a naturally fractured oil formation that also is said to be promising due to the formation's ability to produce oil more quickly and at a lower cost than extraction via fracking.

At the time of the Merger, Crimson had two lines of credit. One was a senior secured revolving credit agreement ("Senior Credit Agreement"), with Wells Fargo as agent, that matured on May 31, 2015. The borrowing base, which was dependent on proved crude oil and natural gas reserves, was $100 million. As of year-end 2012, Crimson had $30.8 million available to it under the Senior Credit Agreement. Crimson had obtained the other credit line, the Second Lien, on or around December 27, 2010, with Barclays Bank Pic as the agent. The Second Lien was a term loan with an aggregate principal of $175 million that matured on December 27, 2015. As of year-end 2012, the entire $175 million principal amount remained outstanding. An affiliate of Oaktree served as one of the Second Lien lenders. The Second Lien charged a variable interest rate based on the higher of: (a) 4%; (b) the prime rate; (c) the Federal Funds Effective Rate plus 0.5%; or (d) the one-month LIBOR rate plus 1%. Both the Senior Credit Agreement and the Second Lien were secured by liens on substantially all of Crimson's assets.

2. Oaktree and Keel; Oaktree and Crimson

A major premise of the Complaint is that Oaktree—alone, in conjunction with its affiliates, or as part of a larger group—controlled Crimson. I pause, therefore, to note the allegations relevant to that assertion. First, the Complaint alleges a longstanding relationship between Keel and Oaktree dating back approximately ten years. The Director Defendants are alleged to have been handpicked by Keel and Oaktree. There are no allegations, however, that Keel ever worked directly for Oaktree or any Oaktree affiliate.

Oaktree is alleged to have exerted control over both Crimson's Board and its management. In this regard, the Complaint alleges that: (1) Oaktree owned 33.7% of Crimson's common stock; (2) Keel and Oaktree had a longstanding relationship; (3) Oaktree handpicked Grady as CFO; (4) the Oaktree Directors comprised three of the seven Board members; (5) the remaining directors were nominated to the Board after Oaktree invested in Crimson and, thus, either were approved or handpicked by Oaktree or an Oaktree employee, such as director Ford; and (6) Crimson's executive officers— namely, Keel, Grady, Mengle, Isaac, Thomas, and Atkins—joined the Company after Oaktree made its investment, and all of them executed support agreements in favor of the Merger.

3. Events leading to the proposed merger

The series of events that led to the Crimson-Contango Merger appear somewhat different depending on whether one reads the Complaint or the Joint Proxy Statement / Prospectus of Contango Oil and Gas Co. and Crimson Exploration, Inc. (the "Proxy Statement").[4] The Proxy Statement indicates that in recent years the Crimson Board and management pursued various potential strategic transactions with other companies and private equity firms, but that, for various reasons, none of those opportunities panned out. Near the end of 2012, management and the Board decided to attempt to identify strategic opportunities more objectively and then pursue them. To that end, Crimson engaged Barclays Capital Inc. ("Barclays") as a financial advisor in early January 2013.[5]

Both the Complaint and the Proxy Statement trace the genesis of the Merger to a conversation between Contango acting CEO Brad Juneau and a Crimson manager at a youth sporting event in early January 2013. After those discussions were reported up the chain of command, Juneau and Keel conferred by telephone on January 9, 2013. Juneau and Keel discussed each company's respective business objectives: Contango sought to diversify its asset base while Crimson desired more working capital to exploit its existing opportunities and increase growth.[6] Contango had only nine full-time employees and lacked depth in management. Thus, as the Complaint repeatedly emphasizes, many members of Crimson's management expected positions in the new company.

Discussions continued over the following weeks. According to the Complaint, management was proceeding without the permission of the Crimson Board. One week after the January 9, 2013, telephone call, Keel, Grady, and Atkins met with Joseph J. Romano, Contango's interim CEO, to discuss the possibility of either a strategic combination or a joint venture to develop the Woodbine properties. The Crimson executives concluded from this meeting that a strategic combination would be superior.[7] Over the next several days, they and Contango negotiated the terms of a confidentiality agreement, which the parties signed by January 21, 2013.[8] Due diligence by both companies followed. Keel and Grady met on January 29 with Barclays to discuss its initial work on evaluating some six different strategic alternatives for Crimson. Crimson management informed Barclays of the preliminary negotiations with Contango, but they had not yet advised the Board about those negotiations. Keel and Grady had a follow-up meeting with Barclays on January 31.[9]

During a telephone call on February 5, 2013, Romano and Keel established a preliminary equity split of 80/20 in favor of Contango. According to the Proxy Statement, that figure was based on preliminary net asset value analyses performed by each company and each company's then-current market capitalization.[10] Keel first contacted representatives of Oaktree regarding a potential merger with Contango on February 6. Oaktree responded favorably. On February 12, Grady and Thomas, Crimson's general counsel, engaged Vinson & Elkins LLP ("Vinson & Elkins") to serve as legal counsel on matters related to the potential merger.[11] The same day, Keel and Romano met to discuss the proposed transaction. On the subject of Crimson's outstanding debt, Romano asked whether Oaktree would consider converting the debt it held under the Second Lien to equity. Oaktree ultimately would reject that request. As negotiations continued, members of Crimson management met with Contango's financial advisors to receive briefings on Contango's properties and assets, including its land contracts.[12] On February 15, Keel and Grady agreed with Romano that an 80/20 split still seemed appropriate. The Complaint alleges, however, that Barclays had not provided Crimson with any valuation or analysis of the proposed deal at this point.

On February 26, 2013, Crimson's Board of Directors held a special meeting to consider the proposed transaction. Based on the information presented by management, the Board responded favorably to continuing negotiations with Contango. Although the Company already was utilizing Barclays for a review of strategic alternatives, the Board also retained Barclays to serve as the Company's financial advisor on the proposed transaction.[13] According to the Proxy Statement, between late February and late April, 2013, members of Crimson management—primarily Keel and Grady—spoke numerous times with Board members, as well as with representatives of Oaktree and ACEC, about the discussions with Contango, the status and results of the due diligence review, and other matters relevant to the Merger. Romano also met several times informally with members of Crimson's Board.[14]

Talks continued through March 2013. On March 5, Grady, Keel, and Thomas met with Vinson & Elkins to discuss the fiduciary duties of the members of Crimson's Board.[15] On March 8, Romano met with Ford, as a representative of Oaktree, to discuss the possibility of exchanging Oaktree's debt under the Second Lien for equity. Ford responded that Oaktree would not agree to such an exchange. Four days later, the Board held its regularly scheduled meeting. Vinson & Elkins reviewed with the Board their fiduciary duties as directors in connection with a strategic merger. Members of management presented information derived from due diligence and informed the Board of their justifications for the business combination with Contango.[16] Barclays also attended the meeting and presented the previously requested strategic review options, as well as the firm's preliminary assessment of the proposed transaction with Contango. Barclays advised the Board that the Company would need significant capital to fully exploit its assets. In that regard, Barclays suggested a merger with a better-capitalized company, a sale of the Company, or a recapitalization as possible ways of acquiring that capital.[17] After discussing these options, the Board found that a strategic merger would be most attractive. Based on this conclusion and the preliminary information it had received, the Board determined that a merger with Contango would provide a significant enhancement in stockholder value.[18]

During the second half of March, 2013, Crimson management met with various representatives of Contango regarding executive employment following the proposed merger. In addition, discussions, diligence, and negotiations regarding the terms of the merger agreement, including various deal protection measures, continued through April.[19]The Crimson Board met telephonically on April 11, 2013, with senior management and representatives from Vinson & Elkins and Barclays to discuss remaining issues regarding the Merger.[20]

Two significant events occurred in mid-April. First, Oaktree sought a Registration Rights Agreement ("RRA") so that it could sell its stock in the combined entity in a private placement. Oaktree retained Kirkland & Ellis LLP to negotiate that agreement. Crimson, Contango, and Oaktree participated in the negotiation of the RRA from April 13 to April 25, 2013.[21] Second, based on the results of its diligence, Contango downwardly revised the estimates of its proved offshore reserves. Thereafter, on April 25, Keel and Romano agreed to a revised equity split of 79.7/20.3.

The negotiations drew to a close in late April 2013. On April 27, the Crimson Board held a telephonic meeting to discuss the Merger and received updates on developments from senior management, Barclays, and Vinson & Elkins. The Board authorized management to finalize the remaining terms, [22] and met again on April 29 to discuss final terms with management and Barclays. Barclays provided its oral opinion that, based on the exchange ratio stated above, the deal was fair, from a financial point of view, to Crimson stockholders.[23] The Board approved the Merger. Director Ni was not present at this meeting, but he later expressed his support for the Merger. Senior management from Crimson and Contango signed the final merger agreement ("Merger Agreement") later in the evening. Crimson and Contango announced the Merger the next day, April 30.

4. The Merger Agreement

The terms of the Merger Agreement called for Contango to acquire Crimson in consideration for 0.08288 shares of Contango for each share of Crimson. This exchange ratio represented a price of approximately $3.19 per share, a 7.7% premium based on the April 29, 2013, trading price of Contango common stock and Crimson common stock. After the Merger, Crimson stockholders owned roughly 20.3% of the combined entity. The now-completed transaction required a majority vote of both Crimson and Contango stockholders. Support agreements entered into in connection with the Merger Agreement locked up some 37.25% of the Crimson stock in favor of the merger.[24] As noted in sections LA and LB supra, numerous members of Crimson management continued to hold positions in the combined entity.

The Merger Agreement included several deal protection measures, including a $7 million termination fee and up to a $4.5 million expense fee. The termination fee represents roughly 1.8% of Crimson's enterprise value.[25] Subject to a fiduciary out, Crimson also agreed to a no-solicitation provision and to provide Contango with matching rights for any superior proposal. Plaintiffs also emphasize that the deal lacked any collar mechanism setting a floor on the trading price of Contango shares.

5. Alleged side consideration

Plaintiffs rely heavily on alleged side consideration provided to Crimson management and Oaktree that was not shared with the common stockholders. It is undisputed that Oaktree received the RRA it sought and that Contango agreed to pay off the entire Second Lien, including a 1% prepayment penalty (the "Prepayment"). These two items are discussed in greater detail below in the context of the Court's analysis of whether Oaktree competed with the common stockholders for consideration. I note, however, that the Complaint does not allege that Oaktree demanded that the Second Lien be repaid in advance in connection with the closing of the Merger. Indeed, the Proxy Statement said only that it is "anticipated that, at or immediately following the effective time of the merger, Crimson's [Second Lien] . . . will be terminated and any indebtedness thereunder repaid."[26] The Proxy Statement similarly stated that the parties expected that Crimson's Senior Credit Agreement, along with Contango's comparable senior debt, would be "amended, restated or replaced."[27] The Complaint also ...


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