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Ford v. Vmware, Inc.

Court of Chancery of Delaware

May 2, 2017

FRANCIS M. FORD, on behalf of himself and all others similarly situated and derivatively on behalf of VMWARE, INC., Plaintiff,
v.
VMWARE, INC., JOSEPH M. TUCCI, MICHAEL W. BROWN, DONALD J. CARTY, JOHN R. EGAN, PAT GELSINGER, PAUL A. MARITZ, PAUL SAGAN, EMC CORPORATION, DENALI HOLDING INC., DELL INC. and UNIVERSAL ACQUISITION CO., Defendants.

          Date Submitted: February 3, 2017

          Michael Hanrahan, Paul A. Fioravanti, Jr., Corinne Elise Amato, PRICKETT, JONES & ELLIOTT, P.A., Wilmington, Delaware; Lee D. Rudy, Michael C. Wagner, Leah Heifetz, KESSLER TOPAZ MELTZER & CHECK, LLP, Radnor, Pennsylvania. Attorneys for Plaintiff.

          Robert S. Saunders, Ronald N. Brown, III, Matthew P. Majarian, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Wilmington, Delaware. Attorneys for Defendants Joseph M. Tucci, Michael W. Brown, John R. Egan, Paul Sagan, Donald J. Carty, and EMC Corporation.

          Donald J. Wolfe, Jr., Matthew E. Fischer, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Jonathan C. Dickey, Paul J. Collins, GIBSON, DUNN & CRUTCHER LLP, Palo Alto, California; Marshall R. King, Jonathan D. Fortney, GIBSON, DUNN & CRUTCHER LLP, New York, New York. Attorneys for Defendants Pat Gelsinger and Paul A. Maritz and Nominal Defendant VMware, Inc.

          Gregory P. Williams, Catherine G. Dearlove, John D. Hendershot, Susan M. Hannigan, RICHARDS, LAYTON & FINGER, P.A.; Wilmington, Delaware; John L. Latham, Brandon R. Williams, ALSTON & BIRD LLP, Atlanta, Georgia; Gidon M. Caine, ALSTON & BIRD LLP, East Palo Alto, California. Attorneys for Defendants Denali Holding Inc., Dell Inc., and Universal Acquisition Co.

          MEMORANDUM OPINION

          LASTER, V.C.

         In October 2015, EMC Corporation entered into a merger agreement with Denali Holding Inc. Nearly a year later, in September 2016, the transaction closed. Through the merger, Denali acquired all of EMC, including EMC's 81% equity interest in VMware, Inc. At the effective time, each publicly traded share of EMC common stock was converted into the right to receive $24.05 in cash plus 0.111 shares of Denali Class V common stock. The Class V shares were a new class of Denali equity, issued in connection with the merger, that tracked the performance of 65% of the value of the block of VMware shares that Denali acquired as a result of the merger.

         A VMware minority stockholder brought this lawsuit, purporting to sue both derivatively on behalf of VMware and as a representative of a putative class of holders of VMware common stock. The complaint recounts a number of negative effects that the EMC-Denali merger had on VMware and the trading price of its common stock. The complaint seeks to turn these negative effects into claims for breach of fiduciary duty against (i) EMC, as VMware's pre-merger controlling stockholder, (ii) individuals affiliated with EMC who served as members of VMware's board of directors, and (iii) Denali, both for allegedly aiding and abetting breaches of duty by the other defendants and as the entity that became VMware's controlling stockholder. The complaint also names as defendants certain Denali affiliates.

         The defendants have moved to dismiss the complaint pursuant to Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief can be granted. This decision grants the defendants' motion.

         I. FACTUAL BACKGROUND

         The facts are drawn from the Second Amended and Supplemented Verified Class Action and Derivative Complaint (the "Complaint") and the documents it incorporates by reference. Additional facts are either undisputed or subject to judicial notice.

         A. The Parties

         Nominal defendant VMware is a Delaware corporation headquartered in Palo Alto, California. It provides "virtualization infrastructure solutions utilized by organizations in building, delivering and consuming information technology resources." Compl. ¶ 5. In layman's terms, it uses software to reproduce systems that historically required separate hardware.

         Defendant EMC is a Massachusetts corporation headquartered in Hopkinton, Massachusetts. Before the merger, its shares traded on the New York Stock Exchange. EMC owned a portfolio of technology businesses, including a controlling stake in VMware.

         Defendant Denali is a Delaware corporation owned by affiliates of Michael Dell, the founder of Dell Inc., and Silver Lake Partners, a private equity firm. In 2013, Mr. Dell took Dell private in a management buyout sponsored by Silver Lake. See In re Appraisal of Dell Inc., 2016 WL 3186538 (Del. Ch. May 31, 2016). Denali is the holding company that Mr. Dell and Silver Lake used to facilitate the transaction and through which they continued to own Dell after the transaction.

         Denali acquired EMC pursuant to a merger agreement dated October 11, 2015 (the "Merger Agreement"). Dell and Universal Acquisition Co., a Denali-owed acquisition vehicle, were also parties to the Merger Agreement. The Complaint named Dell and Universal as additional defendants. For simplicity, this decision generally refers only to Denali, even where Denali technically acted through Dell or Universal.

         B. VMware's Dual-Class Charter

         In 2004, EMC acquired VMware for $635 million. In 2007, while preparing for an initial public offering of VMware equity, EMC caused VMware to adopt an amended and restated certificate of incorporation (the "Dual-Class Charter").

         The Dual-Class Charter authorized two classes of VMware common stock. Class A shares carried one vote per share. Class B shares carried ten votes per share. The Class B shares also carried other special voting rights, such as the exclusive right to elect 80% of the members of VMware's board of directors (the "VMware Board"), whom the Dual-Class Charter referred to as the "Group I Members." The Class B shares had the right to vote together with the Class A shares to elect the remaining 20% of the VMware Board, whom the Dual-Class Charter referred to as the "Group II Members."

         The Class B shares also carried special charter-based veto rights. Article VI of the Dual-Class Charter, titled "CONSENT OF HOLDERS OF CLASS B COMMON STOCK, " provided as follows:

In addition to any other vote required by law or by this Certificate of Incorporation, prior to the Operative Date, the prior affirmative vote of the holders of a majority of the outstanding shares of the Class B Common Stock, voting separately as a class, shall be required to authorize the Corporation to (and (in the case of clauses (iii) through (v) below) authorize or permit any Subsidiary (as defined in Article XI) to):
(i) adopt or implement any stockholder rights plan or similar takeover defense measure;
(ii) consolidate or merge with or into any Person;
(iii) permit any Subsidiary to consolidate or merge with or into any Person
(other than (a) a consolidation or merger of a Wholly-Owned Subsidiary with or into the Corporation or with or into another Wholly-Owned Subsidiary or (b) in connection with a Permitted Acquisition);
(iv) directly or indirectly acquire Stock, Stock Equivalents or assets (including, without limitation, any business or operating unit) of any Person (other than the Corporation or its Subsidiaries), in each case in a single transaction or series of related transactions, involving consideration . . . paid or delivered by the Corporation and its Subsidiaries in excess of $100, 000, 000; provided, however, this clause (iv) of this Section A shall not require the vote of the holders of Class B Common Stock in connection with acquisitions of securities pursuant to portfolio investment decisions in the ordinary course of business or transactions to which the Corporation and one or more Wholly-Owned Subsidiaries are the only parties;
(v) issue any Stock or any Stock Equivalents, except (a) the issuance of shares of Stock of a Wholly-Owned Subsidiary of the Corporation to the Corporation or another Wholly-Owned Subsidiary of the Corporation, (b) pursuant to the Initial Public Offering, or (c) the issuance of shares of Class A Common Stock or options or other rights to purchase Class A Common Stock pursuant to employee benefit plans or dividend reinvestment plans approved by the Board of Directors (provided, however, that notwithstanding the provision of this clause (c), the prior affirmative vote of the holders of a majority of the outstanding shares of the Class B Common Stock, voting separately as a class, shall be required to authorize the Corporation to finally determine the aggregate size of its annual equity grants);
(vi) dissolve, liquidate or wind up the Corporation;
(vii) declare dividends on any class or series of the capital stock of the Corporation;
(viii) enter into any arrangement or agreement with any Person which the Board of Directors determines to be on terms exclusionary to EMC or that are exclusive to such Person, where such Person is offering or proposes to offer products or services that are substantially equivalent to products and services offered by EMC; and
(ix) alter, amend, terminate or repeal, or adopt any provision inconsistent with, in each case whether directly or indirectly, or my merger, consolidation or otherwise, Articles V or VI or Sections A, C through G or J of Article VII of the Amended and Restated Certificate of Incorporation or Sections 2.2, 2.8(D), 2.11, 3.2(A), 3.2(C), 3.9 or 3.11 of the Amended and Restated Bylaws of VMware.

         This decision refers to these provisions as the "Class B Consent Rights." For purposes of this case, the existence of the Class B Consent Rights meant that without EMC's prior approval, the VMware Board could not take meaningful defensive action against EMC, such as by adopting a stockholder rights plan or issuing stock that would materially dilute EMC's controlling position.

         After adopting the Dual-Class Charter, VMware conducted an initial public offering of shares representing 65% of its Class A stock. The newly issued Class A shares were listed on the New York Stock Exchange. EMC retained the remaining 35% of the Class A stock and all of the Class B stock. EMC's combined holdings equated to 81.1% of VMware's total outstanding common stock and 97.4% of its aggregate voting power.

         Through its dominant voting position, EMC controlled VMWare and the composition of the VMware Board. Through its ownership of all of the Class B shares, EMC controlled the election of the Group I Members. Through its combined ownership of 35% of the Class A shares and all of the Class B shares, EMC controlled the election of the Group II Members.

         In practice, EMC caused the VMware Board to consist of seven individuals affiliated with EMC and two independent, outside directors. During the time period covered by the Complaint, five members of the VMware Board also served as members of EMC's board of directors (the "EMC Board"):

• Defendant Joseph M. Tucci joined the VMware Board in 2007. He served as Chairman of the VMware Board and as a member of its Mergers and Acquisitions Committee. He also served as the CEO of EMC and as Chairman of the EMC Board.
• Defendant Michael W. Brown joined the VMware Board in 2007. He chaired its Audit Committee and served as a member of its Compensation and Corporate Governance Committee. He also served as a member of the EMC Board.
• Defendant John R. Egan joined the VMware Board in 2007. He chaired its Mergers and Acquisitions Committee. He also served as a member of the EMC Board.
• Defendant Paul Sagan joined the VMware Board in 2014. He served on its Audit Committee and Compensation Committee. He also served as a member of the EMC Board.
• Defendant Donald J. Carty joined the VMware Board on December 13, 2015. He served on its Audit Committee. He began serving as a member of the EMC Board in January 2015.

         Two other members of the VMware Board were officers of EMC subsidiaries. Defendant Pat Gelsinger was both a director of VMware and its CEO. Before joining VMware in 2012, he served as President and Chief Operating Officer of a division of EMC. Defendant Paul Maritz was both a director of VMware and CEO of Pivotal Software, Inc., another majority-owned subsidiary of EMC. From September 2012 until March 2013, he served as Chief Strategist at EMC. Before that, he served as CEO of VMware.

         Non-parties Pamela Craig and Dennis D. Powell were the two independent members of the VMware Board. Both resigned in December 2015, after the Merger Agreement was executed but before the transaction closed.

         The Complaint names as defendants the members of the VMware Board who were also directors of EMC or who were officers of EMC subsidiaries and hence beholden to EMC for their positions. For simplicity, this decision refers to these defendants as the "Dual Directors."

         C. Approaches From Third Parties

         In July 2014, two activist funds sponsored by Elliot Associates, L.P. accumulated a 2.2% stake in EMC, representing an investment of more than $1 billion. Elliot approached the EMC Board and suggested that EMC spin off VMware.

         EMC entered into a confidentiality and standstill agreement with Elliot. Discussions about a spinoff began, then stalled. On October 8, 2014, Elliot sent an open letter to the EMC Board that argued for a spinoff. After receiving the letter, the EMC Board resumed discussions with Elliot.

         Meanwhile, in September 2014, Denali approached the EMC Board about a potential business combination. EMC entered into a confidentiality agreement with Denali and began discussing a possible deal.

         D. Further Discussions With Denali

         In February 2015, the EMC Board chose to focus on a deal with Denali. Discussions between EMC and Denali continued, and in April 2015, Denali proposed to buy all of EMC's businesses other than VMware for cash. Denali expressed "strong interest" in acquiring a "meaningful" portion of EMC's stake in VMware. Compl. ¶ 30.

         The EMC Board believed that control over VMware was central to Denali's strategic rationale for acquiring EMC. The EMC Board also believed that Denali could not afford to buy all of EMC for cash, including the VMware stake, without incurring an unsustainable level of debt. For a deal to happen, this problem needed to be solved.

         In the past, the EMC Board and management had considered issuing a tracking stock tied to the performance of its stake in VMware, but they had shelved the idea. After receiving Denali's indication of interest, the EMC Board and its advisors evaluated several alternatives to a transaction with Denali, including the potential issuance of a tracking stock. In summer of 2015, the EMC Board, EMC management, and their advisors gave further consideration to a tracking stock while at the same time evaluating the terms of a potential deal with Denali.

         According to the Complaint, at some point the idea of a tracking stock became part of the discussions with Denali:

Incorporation of a tracking stock component in EMC's deal with Denali was inevitable. Either due to a suggestion by EMC, or at the insistence of EMC, on July 15, 2015, the EMC Board received a revised non-binding indication of interest from Denali that included the issuance of non-voting tracking stock intended to track 60% of EMC's economic interest in VMware.

Compl. ¶ 34. It does not necessarily follow that just because EMC was considering a tracking stock, EMC must have proposed the idea of incorporating a tracking stock into the Denali deal. Issuing a tracking stock is one tool that creative financial engineers deploy to unlock value. But it is reasonably conceivable that EMC was the source, so this decision draws that plaintiff-friendly inference.

         In September 2015, Denali submitted two further proposals to EMC. A proposal dated September 1 increased the economic interest represented by the tracking stock from 60% of the VMware stock to 70%, but the tracking stock would not have any voting rights. A proposal dated September 23 kept the economic interest represented by the tracking stock at 60%, but the tracking stock would have voting rights. Notably, the voting rights concerned matters submitted to stockholders of Denali, not VMware. They also comprised a small minority of Denali's outstanding voting power.

         The tracking stock solved Denali's financing problem because it enabled Denali to pay EMC's stockholders less cash and therefore take on less debt. The tracking stock also could reduce the capital gains taxes that EMC's stockholders would owe because the transaction would operate (at least in part) as a stock-for-stock exchange.

         In each of its proposals, Denali valued the tracking stock using the then-current market price of VMware's publicly traded Class A stock. That was logical, since Denali was the potential buyer and wanted to value its acquisition currency as highly as possible. The EMC Board, by contrast, received advice from its financial advisors that the tracking stock would likely trade at a discount to the Class A stock. Evercore LLC explained to the EMC Board that tracking stocks often trade at discounts to the estimated value of the underlying assets. Evercore advised that because of the complexity of the tracking stock and the significant amount of debt that Denali would take on, it was likely that the tracking stock would trade at a discount of up to 10% relative to the Class A stock. Morgan Stanley advised that the tracking stock could trade anywhere from a discount of 5% to a premium of 5% over the Class A stock.

         Because of the overlapping membership between the EMC Board and the VMware Board, a majority of the members of the VMware Board knew about the potential merger, the anticipated Denali tracking stock, and the expectation that it could trade at a discount to the price of VMware's Class A stock. The plaintiff posits that as directors of VMware, the Dual Directors had a duty to use this knowledge to defend VMware and its minority stockholders against the threat of harm from Denali's acquisition of EMC and the issuance of the tracking stock. The Complaint alleges that the Dual Directors failed to act because they were beholden to EMC.

         In support of its theory of disloyal inaction, the Complaint asserts that EMC and the Dual Directors made sure that the four VMware directors who were not also members of the EMC Board-Gelsinger, Maritz, Craig, and Powell-did not learn about the merger until late in the process. The Complaint alleges that on October 6-7, 2015, Tucci, EMC management, and representatives of Morgan Stanley met with Craig, Powell, and certain VMware executives to discuss the merger. At that point, the deal terms were largely set and only four days away from final approval. The plaintiff draws the inference that EMC and the Dual Directors must have known that loyal VMware fiduciaries would have opposed the merger and the issuance of the tracking stock, so they kept the non-conflicted VMware fiduciaries in the dark until it was too late for them to do anything.

         E. The Merger Agreement

         On October 11, 2015, the EMC Board approved the Merger Agreement. It called for Universal to merge with and into EMC, with EMC emerging as a wholly owned subsidiary of Denali (the "Merger"). Each share of EMC common stock would be converted into the right to receive $24.05 in cash plus 0.111 shares of Denali Class V common stock. The Class V stock would track the value of 65% of Denali's 81% interest in VMware, equivalent to about 53% of the equity of VMware.

         The parties to the Merger Agreement valued Denali's Class V stock at $81.78 per share. The Merger Agreement therefore implicitly valued EMC's common stock at $33.15 per share ($24.05 ($81.78 x 0.111)). The transaction implicitly valued EMC's equity at $67 billion and VMware's equity at $33 billion. Morgan Stanley and Evercore opined that the merger consideration as a whole was fair to EMC's common stockholders from a financial point of view.

         To finance the Merger, Denali secured $49.5 billion in debt financing. Denali provided $4.25 billion in equity financing. Without the Class V stock, Denali would have needed another $18 billion to finance the deal.

         In the Merger Agreement, EMC agreed not to take various actions it had the ability to take as a controlling stockholder under the Delaware General Corporation Law (the "DGCL"), such as amending VMware's bylaws. EMC also agreed not to consent to VMware taking any of the actions governed by the Class B Consent Rights, such as adopting a rights plan or issuing additional shares.

         These and other provisions in the Merger Agreement only bound EMC. VMware was not a party to the Merger Agreement. The transaction did not require any action by the VMware Board or VMware's stockholders.

         F. Reactions To The Merger

         Elliott reacted positively to the Merger. In September 2015, Elliot increased its holdings in EMC. On October 12, 2015, after the announcement of the Merger, Elliott released a statement noting that it was "pleased to participate in ...


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