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Ellis v. Gonzalez

Court of Chancery of Delaware

July 10, 2018

KYLE ELLIS, derivatively on behalf of ABBVIE, INC., Plaintiff,

          Submitted: April 3, 2018

          Blake A. Bennett, of COOCH & TAYLOR, PA., Wilmington, Delaware; OF COUNSEL: Francis A. Bottini, Jr. and Albert Y. Chang, of BOTTINI & BOTTINI, INC., La Jolla, California, Attorneys for Plaintiff.

          Lisa A. Schmidt and Daniel E. Kaprow, of RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; OF COUNSEL: Robert J. Kopecky and Joshua Z. Rabinovitz, of KIRKLAND & ELLIS LLP, Chicago, Illinois, Attorneys for Defendants and Nominal Defendant.


          GLASSCOCK, Vice Chancellor.

         This Memorandum Opinion takes yet another stroll through the legal thicket created by the ill-fated corporate inversion merger agreement between pharmaceutical giants AbbVie, Inc., a Delaware corporation, and Shire plc, a citizen of the island of Jersey. An important consideration for the merger, for AbbVie, was the tax savings it stood to realize under the tax laws of a foreign jurisdiction, rather than the United States. That consideration proved ephemeral; during pendency of the merger, the United States Treasury Department announced that it would reinterpret the law so that the tax savings, in part, would no longer be possible. Ultimately, the AbbVie board of directors reversed its recommendation that stockholders approve the merger, and Shire consented to depart the relationship as friends, a bittersweet sentiment no doubt made less bitter by AbbVie's payment of a $1.64 billion breakup fee. Litigation followed on several fronts.

         The Plaintiff here is a stockholder of AbbVie. He seeks to sue the AbbVie board of directors on behalf of the corporation, derivatively. His theory is that AbbVie released misleading statements to the public and stockholders, both before and after the Treasury Department's announcement of its new "regulatory guidance" that bade to destroy the tax advantages of the merger. According to the Plaintiff, these statements were false, and resulted in damage to AbbVie. The Plaintiff failed to demand that the company undertake this litigation, as required by Court of Chancery Rule 23.1, but contends that demand should be excused here. The single ground upon which he argues demand futility is that the Defendants face a substantial risk of liability in the litigation, and therefore are incapable of bringing their business judgment to bear on any such demand.

         As this Court has had many occasions to point out, choses in action like the one at issue here are assets of the corporation, and like any asset are to be deployed according to the business judgment of the directors. Only where a plaintiff pleads specific facts which, if true (and with all reasonable inferences therefrom), demonstrate a substantial risk of liability to a majority of the board, will control of the litigation asset be stripped from the board and given to the putative derivative plaintiff.

         Before me is the Defendants' Motion to Dismiss under Rule 23.1. The Plaintiff points to potential liability on the part of directors for statements made by the company when the merger was announced (and by the company's CEO soon thereafter), saying that tax advantages were but one of several reasons for the merger. He also points to statements by the CEO (and a Shire executive) immediately after the Treasury tax announcement, implying that the merger would go forward nonetheless. All these statements, per the Plaintiff, were false, and imply director liability. Because the AbbVie charter contains a clause exculpating the directors for all liability save for breach of the duty of loyalty, liability here attaches only if the directors acted in bad faith with respect to the statements. I find, even to the extent that the Complaint adequately establishes that the statements were false or misleading, it is bare of non-conclusory allegations that a majority of AbbVie's directors knew of the false statements and nonetheless acted in bad faith. Because the Plaintiff has failed to plead an actionable breach of the duty of loyalty with respect to a majority of the Defendants, demand is not excused, and the Motion to Dismiss must be granted under Rule 23.1.

         My reasoning follows.

         I. BACKGROUND[1]

         A. Parties

         Nominal Defendant AbbVie, Inc. is a Delaware corporation headquartered in North Chicago, Illinois.[2] AbbVie, a biopharmaceutical company, was spun off from Abbott Laboratories in January 2013.[3] By the summer of 2014, AbbVie had become an international conglomerate with approximately 25, 000 employees and a market capitalization of around $86 billion.[4] AbbVie's certificate of incorporation contains a Section 102(b)(7) provision that exculpates its directors from monetary liability for breaches of the duty of care.[5]

         Defendant Richard A. Gonzalez has served as AbbVie's CEO and Chairman since 2013.[6] Defendants Robert J. Alpern, Roxanne S. Austin, William H.L. Burnside, Edward M. Liddy, Edward J. Rapp, Glenn F. Tilton, Roy S. Roberts, and Frederick H. Waddell (the "Director Defendants") served on AbbVie's board during the events described in the Complaint.[7] All of these individuals save Roberts were AbbVie directors when the Complaint was filed.[8]

         Non-party Shire plc is a biopharmaceutical company incorporated in the Channel Island of Jersey.[9] Shire is headquartered in Dublin, Ireland.[10]

         Plaintiff Kyle Ellis has held AbbVie stock continuously since January 2013.[11]

         B. Factual Background

         This case stems from AbbVie's proposed acquisition of Shire, which was abandoned after the United States Treasury Department announced in September 2014 that it would take steps to make so-called "inversion transactions"[12] less attractive.[13] The crux of the Complaint is that AbbVie's directors breached their fiduciary duties by making material misrepresentations and omissions in connection with the botched acquisition.[14] While the Complaint exhaustively describes the negotiations leading up to the merger, [15] the details of those negotiations are largely irrelevant to the issues presented by the Defendants' Motion. I recite only those facts necessary to understand the Plaintiff's disclosure claims.

         1. AbbVie and Shire Agree to Merge, and AbbVie Touts the Benefits of the Proposed Acquisition

         After months of negotiations, on July 18, 2014, AbbVie and Shire entered into an agreement whereby AbbVie would acquire Shire for approximately $54 billion.[16]Under the agreement, AbbVie would form a wholly owned Jersey subsidiary ("New AbbVie"), acquire Shire for a mix of cash and New AbbVie stock, and convert AbbVie common stock into New AbbVie stock.[17] AbbVie and Shire would then become wholly owned subsidiaries of New AbbVie.[18] If AbbVie's board withdrew its support for the transaction, AbbVie would pay Shire a $1.64 billion termination fee.[19] This amount, though facially large, was an unremarkable 3% of deal value. If AbbVie's board did not withdraw its support, but AbbVie's stockholders nevertheless voted down the deal, AbbVie would pay Shire no less than $500 million and no more than $545 million to compensate Shire for costs incurred as part of the transaction.[20]

         When AbbVie announced the agreement with Shire, it listed seven strategic rationales for the merger:

• Larger and more diversified biopharmaceutical company with multiple leading franchises.
• Adds leading franchises with specialty therapeutic areas, including rare disease and neurosciences.
• Broad and deep pipeline of diverse development programs and enhanced R&D capabilities.
• Global resources and experienced teams positioned to continue to deliver strong shareholder returns to both AbbVie and Shire shareholders.
• Transaction expected to achieve a competitive tax structure and provide New AbbVie with enhanced access to its global cash flows.
• Transaction expected to be accretive to adjusted EPS in the first year following completion, and will increase to more than $1.00 per share by 2020.
• Significant financial capacity for future acquisitions, investment and opportunity for enhanced shareholder distributions and value creation.[21]

         Later, during a July 21, 2014 investor conference, AbbVie CEO Richard A. Gonzalez stated that the merger "has a significant, both strategic and financial, rationale. Tax is clearly a benefit, but it's not the primary rationale for this."[22]Gonzalez reiterated that the transaction "has compelling financial impact well beyond the tax impact," and that "[w]e would not be doing it if it was just for the tax impact."[23] According to Gonzalez, the tax impact was "an additional benefit that we have."[24]

         One month after the investor conference, AbbVie filed a Form S-4 that listed ten rationales for the transaction, including "the combined financial strength and R&D experience of New AbbVie," and the "opportunity for New AbbVie to have an enhanced financial profile and greater strategic and financial flexibility as compared to AbbVie and Shire on a standalone basis."[25] As the Plaintiff points out, AbbVie mentioned tax benefits as only one of the justifications for the transaction, touting "the potential realization of tax and operational synergies by New AbbVie as a result of the Merger."[26] But the Complaint does not allege that the Form S-4 contained false or misleading statements; indeed, it contrasts the disclosures in the Form S-4 with Gonzalez's purportedly misleading statements at the July 21 investor conference.[27]

         2. The Regulatory Environment Shifts, and AbbVie Terminates the Merger

         On September 22, 2014, the Treasury Department announced its plan to issue regulatory guidance that would eliminate some of the tax advantages of merger-based inversions.[28] The Treasury Department stated that the changes would "eliminate[] certain techniques inverted companies currently use to access the overseas earnings of foreign subsidiaries of the U.S. company that inverts without paying U.S. tax."[29] The summer before this announcement, there were signs that the United States government was considering steps to limit inversions.[30] For example, on August 5, 2014, the Treasury Department announced that it was "reviewing a broad range of authorities for possible administrative actions to limit inversions as well as approaches that could meaningfully reduce the tax benefits after inversions took place."[31]

         According to the Plaintiff, the September 22 announcement "immediately caused AbbVie's Board to convene an emergency discussion about the effect of the [announcement] and whether AbbVie should continue with the Merger."[32] One week after the announcement, on September 29, AbbVie filed two Form 425s; one contained a letter from Gonzalez to Shire's employees, and the other included a letter from AbbVie Vice President Chris C. Turek to AbbVie's employees.[33] Gonzalez said in his letter that he was "more energized than ever about our two companies coming together," that "[w]e have a very busy few months ahead as we work on integration planning," and that he "look[ed] forward to working with you much more closely in the near future."[34] Similarly, Turek wrote in his letter that the company would "concentrate on remaining requirements in a coordinated manner until [AbbVie and Shire] are fully integrated," and that "both integration planning teams are committed to successful preparation for Day One."[35] Neither the Form 425s nor the letters themselves were signed by any members of the AbbVie board.[36]

         On October 14, AbbVie announced that the board intended to "reconsider the recommendation made on July 18, 2014 that AbbVie stockholders adopt the merger agreement needed to complete the proposed Merger of AbbVie and Shire."[37] The announcement noted that the AbbVie board would "consider, among other things, the impact of the U.S. Department of Treasury's proposed unilateral changes to the tax regulations announced on September 22, 2014, including the impact to the fundamental financial benefits of the transaction."[38] One day later, AbbVie issued a press release announcing that the board had decided to withdraw its recommendation that stockholders vote in favor of the merger.[39] According to the press release, AbbVie and its board "made this determination following a detailed consideration of the impact of the U.S. Department of Treasury's unilateral changes to the tax rules."[40] Shire's stock price dropped from a closing price of $244.57 on October 14 to a low of $156.25 on October 15.[41]

         On October 21, AbbVie issued another press release, this time to announce that AbbVie and Shire had agreed to terminate the proposed merger.[42] The announcement disclosed that AbbVie had agreed to pay Shire the $1.64 billion termination fee.[43] AbbVie explained that the changes proposed by the Treasury Department had "introduced an unacceptable level of risk and uncertainty given the magnitude of the proposed changes and the stated intention of the Department of Treasury to continue to revise tax principles to further impact such transactions."[44]Thus, "[t]he executive management team ultimately concluded that the transaction was no longer in the best interests of stockholders at the agreed upon valuation, and the Board fully supported that conclusion."[45]

         3. The Securities Fraud Class Action

         On November 25, 2014, several Shire stockholders filed a securities fraud class action against AbbVie and Gonzalez (the "Federal Action").[46] The complaint there alleged that AbbVie and Gonzalez had made several false and misleading statements in connection with the Shire merger, statements that supposedly downplayed the importance of tax benefits to the transaction.[47] On March 10, 2017, the court granted in part and denied in part the defendants' motion to dismiss, holding that the plaintiffs had stated a claim under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 based on Gonzalez's statements in the September 29, 2014 letter.[48] According to the court, the complaint supported a reasonable inference that "AbbVie's omission of the fact that it was reconsidering the merger rendered misleading Gonzalez's [September 29] statement about the continued planning for the transaction."[49] The court then held that the plaintiffs had adequately alleged scienter, finding it reasonable to infer that the September 29 letter "was made with a reckless disregard for the known or obvious danger of misleading buyers into believing that AbbVie still fully intended to go forward with the merger when, in fact, AbbVie was in the process of analyzing whether to walk away from the deal in light of the tax rule changes."[50] The Federal Action remains pending.

         C. This Litigation

         The Plaintiff commenced this action on May 4, 2017. The Complaint contains a single count for breach of fiduciary duties against the Defendants.[51] According to the Plaintiff, the Defendants knowingly or recklessly issued false and misleading statements about the proposed transaction, and failed to promptly disclose that the AbbVie board was reconsidering the deal after the September 22, 2014 notice issued by the Treasury Department.[52] On May 30, 2017, the Defendants moved to dismiss the Complaint under Court of Chancery Rule 23.1, arguing that the Plaintiff fails to adequately allege a majority of AbbVie's directors face a substantial likelihood of liability for breach of fiduciary duty. I heard oral argument on that Motion on April 3, 2018.

         II. ANALYSIS

         The Defendants seek dismissal of the Complaint under Court of Chancery Rule 23.1 for failure to make a demand. The demand requirement is an extension of the fundamental principle that "directors, rather than shareholders, manage the business and affairs of the corporation."[53] Directors' control over a corporation embraces the disposition of its assets, including its choses in action. Thus, under Rule 23.1, a derivative plaintiff must "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort."[54]

         Where, as here, the plaintiff has failed to make a presuit demand on the board, the Court must dismiss the complaint "unless it alleges particularized facts showing that demand would have been futile."[55] The plaintiff's "pleadings must comply with stringent requirements of factual particularity that differ substantially from the permissive notice pleadings governed solely by Chancery Rule 8(a)."[56] Under the heightened pleading requirements of Rule 23.1, conclusory "allegations of fact or law not supported by allegations of specific fact may not be taken as true."[57]Nonetheless, the plaintiff is "entitled to all reasonable factual inferences that logically flow from the particularized facts alleged."[58] In deciding a Rule 23.1 motion, I am limited to "the well-pled allegations of the complaint, documents incorporated into the complaint by reference, and judicially noticed facts."[59]

         This Court analyzes demand futility under the test set out in Rales v. Blasband.[60] Rales requires a derivative plaintiff to allege particularized facts raising a reasonable doubt that, if a demand had been made, "the board of directors could have properly exercised its independent and disinterested business judgment in responding to [it]."[61] Aronson v. Lewis addresses the subset of cases in which the plaintiff is challenging an action taken by the current board.[62] To establish demand futility under Aronson, the plaintiff must allege particularized facts creating a reasonable doubt that "the directors are disinterested and independent" or the "challenged transaction was otherwise the product of a valid exercise of business judgment."[63] The tests articulated in Aronson and Rales are "complementary versions of the same inquiry."[64] That inquiry asks whether the board is capable of exercising its business judgment in considering a demand.[65]

         Here, the Plaintiff does not argue that demand is futile because the Defendants have a financial interest in the conduct described in the Complaint, or because they lack independence from an interested party.[66] Instead, the Plaintiff claims that the Defendants cannot impartially consider a demand because they face a substantial likelihood of liability for AbbVie's making material misrepresentations and omissions in connection with the abandoned Shire acquisition. AbbVie's certificate of incorporation contains a Section 102(b)(7) clause that exculpates the directors from liability for duty-of-care violations. Thus, under either Aronson or Rales, the question here is the same: Does the Complaint adequately allege that a majority of AbbVie's board faces a substantial likelihood of liability for breaching the duty of loyalty?[67] Such a board, obviously, would be fatally conflicted in evaluating a demand.

         To establish a substantial likelihood of liability, a plaintiff need not "demonstrate a reasonable probability of success on the claim."[68] Rather, the plaintiff must "make a threshold showing, through the allegation of particularized facts, that [its] claims have some merit."[69] "This standard recognizes that the purpose of the particularity requirement is not to prevent derivative actions from going forward, but rather 'to ensure only derivative actions supported by a reasonable factual basis proceed.'"[70]

         A. Demand Is Not Futile as to the Disclosure Claims

         According to the Plaintiff, the Director Defendants face a substantial risk of liability for approving-or failing to correct-materially misleading statements regarding the proposed Shire transaction. Specifically, the Plaintiff alleges that the Director Defendants (i) caused AbbVie and Gonzalez to make statements in July 2014 that downplayed the importance of tax benefits to the merger, even though those benefits were the primary rationale for pursuing the transaction; and (ii) knowingly failed to correct Gonzalez's and Turek's purportedly misleading statements in the Form 425s filed on September 29, 2014, thereby creating the impression that AbbVie was still committed to the merger even though, according to the Plaintiff, the board had already begun reassessing the transaction. In my view, neither of these theories establishes that the Director Defendants face a substantial likelihood of liability for breaching the duty of loyalty. Thus, demand is not excused.

         The duty of disclosure "is not an independent duty, but derives from the duties of care and loyalty."[71] Because the "scope and requirements" of the duty of disclosure "depend on context," Delaware law has developed specific rules for applying the duty in different factual scenarios.[72] Among those scenarios are (i) requests for stockholder action, (ii) communications outside the context of stockholder solicitation, (iii) attempts to seek ratification of transactions that do not require a stockholder vote, and (iv) direct sales or purchases of stock by corporate fiduciaries.[73] The statements at issue in this case were not made in the context of requests for stockholder action, and they did not relate to stock transactions or attempts to obtain ratification. Thus, the challenged communications fall within the Malone v. Brincat line of cases.[74]

         Malone established that directors owe a duty not to knowingly disseminate false information to stockholders, even when the directors are not seeking stockholder action.[75] To plead a disclosure claim where there is no request for stockholder action, a plaintiff must allege that the directors "deliberately misinform[ed] shareholders about the business of the corporation, either directly or by a public statement."[76] As the Malone Court explained:

Whenever directors communicate publicly or directly with shareholders about the corporation's affairs, with or without a request for shareholder action, directors have a fiduciary duty to shareholders to exercise due care, good faith and loyalty. It follows a fortiori that when directors communicate publicly or directly with shareholders about corporate matters the sine qua non of directors' fiduciary duty to shareholders is honesty.[77]

         Because AbbVie's charter contains a Section 102(b)(7) exculpatory provision, the Plaintiff here cannot establish demand futility based on his disclosure claims unless he "plead[s] particularized factual allegations that 'support the inference that the disclosure violation[s] w[ere] made in bad faith, knowingly or intentionally."[78]

         1. The July 2014 Statements

         The first set of purported misstatements were made in July 2014. After AbbVie and Shire agreed to merge on July 18, 2014, AbbVie gave an investor presentation listing seven strategic rationales for the transaction. Only one of those rationales invoked tax benefits: "Transaction expected to achieve a competitive tax structure and provide New AbbVie with enhanced access to its global cash flows."[79]The other benefits of the transaction included "[b]road and deep pipeline of diverse development programs and enhanced R&D capabilities," and "[l]arger and more diversified biopharmaceutical company with multiple leading franchises."[80] Later, at a July 21 investor conference, Gonzalez said that tax benefits were "not the primary rationale for [the merger], "[81] and that "[w]e would not be doing it if it was just for the tax impact."[82] Gonzalez also claimed that the deal "has a significant, both strategic and financial, rationale."[83]

         According to the Plaintiff, all of these statements were materially misleading because they downplayed the importance of tax benefits to the transaction. Indeed, the Plaintiff argues that tax savings were the primary justification for the merger, rendering misleading any statements that suggested otherwise. In my view, however, none of these statements gives rise to a substantial threat of personal liability for the Director Defendants.

         First, the Complaint fails to adequately allege that any of these statements were false or misleading. The Plaintiff's theory of falsity rests on the premise that tax benefits were the sole, or at least primary, rationale for the merger. To support this premise, the Plaintiff points to AbbVie's October 15, 2014 press release. There, the company announced that the board had withdrawn its recommendation in favor of the merger "following a detailed consideration of the impact of the U.S. Department of Treasury's unilateral changes to the tax rules."[84] The Plaintiff argues that, because the limitation of tax benefits caused AbbVie's board to withdraw its support for the merger, those benefits must have provided the true, substantive rationale for the deal. But that is a specious argument. Tax advantages may have been a necessary component of the deal-that is, a benefit whose loss (or limitation) would make the merger untenable at the agreed-upon price. It does not follow, however, that tax benefits were the main (or only) reason AbbVie pursued the transaction.[85] And, contrary to the Plaintiff's conclusory allegation, [86] AbbVie did not suggest in July 2014 that the merger would close if the tax benefits fell away. All AbbVie said was that tax savings were not sufficient, standing alone, to justify the merger, and that they were one among several considerations supporting the transaction. There was nothing inferentially false or misleading about that.

         The court in Rubinstein-the securities fraud class action premised on essentially the same set of purported misstatements as the present case-recognized the flaw in the Plaintiff's theory of falsity. The Rubinstein court reasoned thus:

[T]he total value of the deal was $54 billion. The break-up fee was $1.64 billion, or approximately 3% of the total value. Given this deal structure, it would be expected that AbbVie's loss of any benefit worth 3% or more of the total deal value could cause AbbVie to terminate the deal. But it does not follow that any benefit of the deal that is worth at least 3% of the transaction value must be the "primary"-i.e. the "most important"-reason for the deal. As the Court previously concluded, "[s]aying a benefit is not the 'primary rationale' is not the same as saying it is immaterial or unimportant."[87]

         Indeed, for the Plaintiff's theory of falsity to succeed, he would have to plead with particularity that most of the value of the merger to AbbVie stemmed from the expected tax benefits, or specifically plead facts implying ...

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