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In re Sanchez Energy Derivative Litigation

Court of Chancery of Delaware

November 25, 2014

IN RE SANCHEZ ENERGY DERIVATIVE LITIGATION

Submitted: August 11, 2014

Stuart M. Grant, Michael J. Barry, Nathan A. Cook, Bernard C. Devieux, and Jacob R. Kirkham, of GRANT & EISENHOFER P.A., Wilmington, Delaware, and Pamela S. Tikellis, Scott M. Tucker, Tiffany J. Cramer, and Vera G. Belger, of CHIMICLES & TIKELLIS LLP, Wilmington, Delaware; OF COUNSEL: Mark Lebovitch, Amy Miller, and Evan Berkow, of BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP, New York, New York, Attorneys for the Plaintiffs.

John D. Hendershot and Andrew J. Peach, of RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware, Attorneys for Defendants Gilbert A. Garcia, Alan G. Jackson and Greg Colvin.

Peter B. Ladig, Jason C. Jowers, and Elizabeth A. Powers, of MORRIS JAMES LLP, Wilmington, Delaware; OF COUNSEL: R. Thaddeus Behrens and Daniel H. Gold, of HAYNES & BOONE LLP, Dallas, Texas, Attorneys for Defendants Eduardo Sanchez and Sanchez Resources, LLC.

William M. Laffery, Leslie A. Polizoti, and Lauren K. Neal, of MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; OF COUNSEL: M. Scott Barnard and Michelle A. Reed, of AKIN GUMP STRAUSS HAUER & FELD LLP, Dallas, Texas, Attorneys for Defendants A.R. Sanchez Jr. and A.R. Sanchez III.

Rolin P. Bissell and Tammy L. Mercer, of YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; OF COUNSEL: Michael C. Holmes and Jeremy M. Reichman, of VINSON & ELKINS LLP, Dallas, Texas, Attorneys for Defendants Altpoint Capital Partners LLC and Altpoint Sanchez Holdings LLC.

Kurt M. Heyman, Patricia L. Enerio, and Dawn Kurtz Crompton, of PROCTOR HEYMAN LLP, Wilmington, Delaware, Attorneys for Nominal Defendant Sanchez Energy Corp.

MEMORANDUM OPINION

GLASSCOCK, Vice Chancellor

This case tests the limits of our pleading requirements under Court of Chancery Rule 23.1. The Plaintiffs are stockholders who seek to derivatively pursue claims for breach of fiduciary duty against the corporation, arising from a transaction in which the corporation purchased assets from another entity controlled by two members of the corporation's board of directors. The Plaintiffs did not make a pre-suit demand on the board. The transaction at issue was approved by the corporation's audit committee, which is specifically empowered by the board of directors to review, and approve or reject, such transactions. The audit committee is composed of the three other, disinterested board members, and was assisted by a financial advisor in approving the transaction.

In arguing that demand should be excused, the Plaintiffs point to the conflicted directors' managerial control over the corporation and what they see as the disadvantageous nature of the transaction itself, together with conclusory allegations that two of the three disinterested directors lacked independence. The Complaint is silent about the process by which the audit committee evaluated the transaction, however; indeed, it must be, because the Plaintiffs failed to pursue information about the process, through a demand under Section 220 or otherwise. If the procedural requirements of Rule 23.1 are to be meaningful and effective, more than conclusory allegations of directors' lack of independence is required before control of litigation is shifted from the board to the stockholders. Accordingly, and for the reasons that follow, I grant the Defendants' Motions to Dismiss.

I. BACKGROUND FACTS

Sanchez Energy Corporation ("Sanchez Energy, " or the "Company") is a publicly traded Delaware corporation "focused on the acquisition, exploration, and development of unconventional oil and natural gas resources onshore along the U.S. Gulf Coast." [1] Sanchez Energy was established in 2011 by certain members of the Sanchez family, two of whom—A. R. Sanchez Jr., a 16% stockholder, and A. R. Sanchez III, a 5.5% stockholder—have since served on the Company's board of directors. In addition to Sanchez Jr. and Sanchez III, Sanchez Energy's board of directors consists of individual Defendants Alan G. Jackson, Gilbert A. Garcia, and Greg Colvin.

According to the Plaintiffs, in addition to its minority equity stake in Sanchez Energy, the Sanchez family also owns and operates a "web of four privately held, affiliated companies, "[2] including Sanchez Resources, LLC ("Sanchez Resources-). In 1978, Sanchez Jr. and his father founded Sanchez Oil & Gas Corporation ("SOG"), a company that specializes in managing oil drilling operations; Sanchez Jr. is the CEO and Chairman of SOG, which provides management services to all Sanchez-affiliated entities, including Sanchez Energy. Apart from directors, officers, and management services obtained from SOG, Sanchez Energy "has no employees and no directly managed operations." [3] In addition, SOG grants Sanchez Energy "a license to the unrestricted proprietary seismic, geological and geophysical information owned by SOG that is related to the Company's properties." [4] SOG, Sanchez Energy, and Sanchez Resources all operate out of the same building complex in Houston, Texas.

In August 2013, Sanchez Energy entered into a transaction (the "Transaction") with Sanchez Resources for the purchase of "working interests"— rights to develop land and extract oil, subject to royalty payments owed to landowners—in Sanchez Resources' "Tuscaloosa Marine Shale" ("TMS") project. Prior to the Transaction, Sanchez Resources held working interests in 40, 000 acres of developed land and 40, 000 acres of undeveloped land in the TMS, and Altpoint Capital Partners LLC ("Altpoint") held an unspecified equity stake in Sanchez Resources. When oil reserves were proven on the 40, 000 acres of developed land, Sanchez Resources sought to develop the remaining undeveloped acreage, but Altpoint declined to make an additional investment to fund that development. Sanchez Resources and Altpoint therefore sought a third party willing to buy out Altpoint's equity interest and to fund the additional development. Sanchez Resources and Altpoint found that third party in Sanchez Energy: the Company agreed to purchase Altpoint's working interests in the TMS, but structured the Transaction as a joint venture rather than an equity investment.

The Transaction was structured in three legs: Sanchez Resources transferred its working interests in the 40, 000 acres of undeveloped land to Altpoint; Altpoint transferred those same interests to Sanchez Energy; and then Sanchez Energy transferred the interests back to Sanchez Resources, in exchange for an undivided one-half interest in both the 40, 000 acres of undeveloped land and the 40, 000 acres of developed land. As consideration, Sanchez Energy paid roughly $77 million in cash and stock, with approximately $62 million flowing to Altpoint and $15 million flowing to Sanchez Resources. In addition, Sanchez Energy committed to constructing six oil wells on the undeveloped property—a benefit of approximately $22 million to Sanchez Resources, according to the Plaintiffs—and agreed to pay additional royalties to Sanchez Resources on future revenues from oil extracted from the undeveloped property. According to the Plaintiffs, Sanchez Energy's $77 million payment valued the Transaction at approximately seventeen times the value of an August 2013 "comparable arms-length transaction[] in the TMS" between Goodrich Petroleum Corp., the largest acreage owner in the TMS, and Devon Energy, "a true third party." [5] By another of the Plaintiffs' calculations, Sanchez Energy paid roughly $2, 500 per acre for the same working interests that Sanchez Resources had purchased in 2010, prior to development, at $184 per acre.

The Complaint does not detail the parties' negotiations leading up to the Transaction, or even identify which principals at Sanchez Energy negotiated its terms. Defendants Jackson, Garcia, and Colvin, acting as the Company's audit committee (the "Audit Committee")—a committee created for the express purpose of evaluating and approving interested-party transactions between the Company and Sanchez family members[6]—considered and approved the Transaction, with the advice of an independent financial advisor. Although the Complaint contains few specific allegations detailing the Audit Committee's evaluation of the Transaction, the Plaintiffs contend that the members of the Audit Committee lacked independence from Sanchez Jr. and Sanchez III, and that the Committee's approval of the Transaction is therefore not entitled to deference under the business judgment rule. While the Plaintiffs conceded Colvin's independence in briefing and at oral argument, [7] the Plaintiffs allege that Jackson and Sanchez Jr. "have been close friends for more than five decades, " and that "Jackson is beholden to Sanchez Jr. in his professional career." [8] According to the Plaintiffs, Jackson is employed as an executive at IBC Insurance Agency, Ltd. ("IBC"), the subsidiary of International Bancshares Corporation, for which Sanchez Jr. serves as one of nine directors and in which the "Sanchez family-—a group undefined in the Complaint—―are the largest stockholders." [9] The Complaint therefore alleges that:

If Jackson, in his capacity as a director at Sanchez Energy, were to act against the interests of Sanchez Jr., he faces the threat of termination at IBC, the loss of promotion opportunities, and the loss or decrease of his salary—his very livelihood—because of Sanchez Jr.'s position on IBC's board [sic] and significant influence through his substantial equity stake.[10]

To be clear, the Plaintiffs argue that Jackson would face these negative consequences because of Sanchez Jr.'s position on IBC's parent company's board—International Bancshares Corporation—not because of Sanchez Jr.'s position on IBC's board, as their language above suggests. The Complaint does not allege, and the Plaintiffs have not argued, that Sanchez Jr. also serves directly ...


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