FRANCIS M. FORD, on behalf of himself and all others similarly situated and derivatively on behalf of VMWARE, INC., Plaintiff,
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.
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.
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
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.
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.
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.
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
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.
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
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
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
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.
VMware's Dual-Class Charter
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
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
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
(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
(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.
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.
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
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.
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.
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.
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
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."
Approaches From Third Parties
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.
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.
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
Further Discussions With Denali
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.
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.
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
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.
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.
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.
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.
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.
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.
The Merger Agreement
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
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.
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.
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.
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
Reactions To The Merger
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