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English v. Narang

Court of Chancery of Delaware

March 20, 2019

ARON ENGLISH and RICHARD PEPPE, Individually and on Behalf of All Similarly Situated Individuals, Plaintiffs,

          Date Submitted: December 18, 2018

          Blake A. Bennett, COOCH AND TAYLOR, P.A., Wilmington, Delaware; W. Scott Holleman and Garam Choe, JOHNSON FISTEL, LLP, New York, New York; Counsel for Plaintiffs.

          Elena C. Norman and Daniel M. Kirshenbaum, YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Joshua Z. Rabinovitz, KIRKLAND & ELLIS LLP, Chicago, Illinois; Devora W. Allon, KIRKLAND & ELLIS LLP, New York, New York; Counsel for Defendants.


          BOUCHARD, C.

         In January 2016, the board of directors of NCI, Inc. engaged two financial advisors to solicit interest in a sale of the company. In July 2017, after a sale process that lasted eighteen months and resulted in at least five other firms expressing interest in acquiring NCI, the company entered into a merger agreement to sell the company for $20 per share in cash to affiliates of H.I.G. Capital, LLC. The transaction was structured as a tender offer followed by a merger. Charles Narang, NCI's founder who held about 34% of NCI's shares and about 83.5% of the company's voting power, tendered his shares for the same per-share consideration that every other stockholder received in the transaction.

         In March 2018, over seven months after the transaction closed, two former stockholders of NCI filed this action asserting claims against NCI's directors for breach of fiduciary duty and against H.I.G. and its affiliates for aiding and abetting breaches of fiduciary duty. Defendants moved to dismiss these claims under Court of Chancery Rule 12(b)(6) for failure to state a claim for relief. Their lead argument is that the complaint must be dismissed under Corwin v. KKR Financial Holding LLC[1] because a majority (approximately 73.6%) of NCI's disinterested stockholders tendered their shares in an uncoerced and fully-informed tender offer, subjecting the transaction to business judgment review.

         Plaintiffs advance two reasons why they believe Corwin should not apply. First, they contend that the transaction should be subjected to entire fairness review on the theory that Narang orchestrated a sale of the company for less than fair value to address a personal need for liquidity prompted by his retirement as the company's CEO in 2015 at seventy-three years of age. Second, they contend that the other stockholders who tendered their shares were not fully informed when they did so because the recommendation statement for the transaction was misleading and omitted material information.

         For the reasons explained below, the court concludes that neither of plaintiffs' theories against applying Corwin holds water based on the facts plead in the complaint and this court's precedents. Thus, the transaction is subject to business judgment review and plaintiffs' claims must be dismissed for failure to state a claim for relief.

         I. BACKGROUND

         The facts recited herein are taken from the Verified Class Action Complaint filed on March 28, 2018 (the "Complaint") and documents incorporated therein.[2] Any additional facts are either not subject to reasonable dispute or subject to judicial notice.

         A. The Players

         NCI, Inc. ("NCI" or the "Company") is a Delaware corporation headquartered in Virginia that provides enterprise solutions and services to United States "defense, intelligence, health and civilian government agencies."[3] Before the transaction at issue (the "Transaction"), NCI had two classes of common stock: (i) Class A shares with one vote per share that traded publicly and (ii) Class B shares with ten votes per share that were convertible into Class A shares on a one-for-one basis.

         Plaintiffs Aron English and Richard Peppe allege they owned shares of NCI common stock at all relevant times. The number of shares they held is not alleged.

         The individual defendants consist of the seven members of NCI's board of directors (the "Board") when it approved the Transaction. Defendant Charles K. Narang was the Company's CEO and Chairman of the Board from its formation until October 1, 2015, and continued to serve as Chairman of the Board until the Transaction closed in August 2017. Narang also was NCI's largest stockholder. As of December 31, 2016, Narang owned 117, 659 shares or 1.3% of the Class A shares outstanding and 4.5 million shares or 100% of the Class B shares outstanding. This equated to 34% of NCI's total number of shares of common stock outstanding and 83.5% of the Company's total voting power.[4]

         Defendant Paul A. Dillahay served as NCI's President and CEO and as a director from October 31, 2016 through the completion of the Transaction. Defendants James P. Allen, Paul V. Lombardi, Cindy E. Moran, Austin J. Yerks, and Daniel R. Young were all directors of NCI who are not alleged to have had any management positions with the Company.

         Defendant H.I.G. Capital LLC ("H.I.G."), a Delaware limited liability company headquartered in Miami, Florida, is a global private equity investment firm. The remaining two defendants are Delaware entities affiliated with H.I.G.: Cloud Intermediate Holdings, LLC and its subsidiary, Cloud Merger Sub, Inc. These three entities are collectively referred to as the "H.I.G. Defendants."

         B. Narang's Tenure as NCI's CEO

         In 1989, Narang established the predecessor of NCI (NCI Information Systems, Inc.) as a Virginia corporation. NCI acquired that entity in 2005 as part of a plan to take the Company public. In 2015, after a twenty-six-year tenure as the Company's CEO, Narang decided to step down from that role. On July 29, 2015, NCI issued a press release announcing that Narang would be stepping down as CEO. NCI's incoming CEO, Brian J. Clark, stated in the press release that NCI "intend[ed] to explore new strategic avenues for the company . . . includ[ing] acquisitions and other options."[5]

         C. NCI Retains Advisors and Begins a Sale Process

         In January 2016, the Board engaged two financial advisors-Wells Fargo Securities, LLC and Stifel, Nicolaus & Company, Inc.-to pursue a sale of the Company. During the first half of 2016, Wells Fargo and Stifel contacted "various potential buyers" but only one party emerged as a serious bidder-a private equity firm known as Party A.[6] It subsequently withdrew from the process because of regulatory concerns relating to one of Party A's portfolio companies.

         On October 16, 2016, Clark unexpectedly resigned as CEO after serving in the position for little more than one year. Dillahay later was appointed as NCI's new CEO.

         D. H.I.G. Enters the Sale Process

         In November 2016 and January 2017, NCI representatives received unsolicited communications from H.I.G., expressing interest in meeting with Dillahay to discuss a potential business relationship. Discussions ceased for a time after NCI announced on January 23, 2017 that its former controller had embezzled nearly $20 million from the Company between January 2010 and January 2017.

         On February 22, 2017, H.I.G. reinitiated contact with NCI to discuss its business operations and express H.I.G.'s desire to buy NCI. On March 8, 2017, H.I.G. contacted Dillahay and proposed acquiring NCI for $18 per share. Two days later, NCI received interest from another private equity firm ("Party C") to acquire NCI for $19 per share. In response, the Board instructed Dillahay to contact H.I.G. to advise it of the existence of another buyer and to request that H.I.G. increase its offer to $20 per share. Three days later, H.I.G. contacted Dillahay and indicated that H.I.G. was willing to offer between $19 and $21 per share, which was later memorialized in writing.

         On March 16, 2017, Party C submitted a revised bid to acquire NCI for $20 per share. The next day, the Board met with Wells Fargo and Stifel to discuss the status of negotiations with H.I.G. and Party C. Dillahay later had discussions with the founder of Party C about the possibility of NCI acquiring an entity controlled by Party C's founder, but the Board vetoed this idea on March 29, 2017.

         On April 5, 2017, NCI announced its earnings for both the full year and fourth quarter ended on December 31, 2016. During an investor conference call held that day to discuss NCI's results, Dillahay discussed a strategic growth plan for the Company that focused on three issues: (1) ensuring that the Company's personnel were well-equipped for NCI's business, (2) "increasing operational performance to improve margins," and (3) "overhaul[ing] the business pipeline to focus on larger, more profitable opportunities."[7] During this call, Dillahay also underscored that NCI possessed a lot of untapped potential, noted improving market conditions that bode well for NCI's success, and expressed confidence in NCI's ability to execute the plan. Dillahay further noted that "NCI's win rates and recompetes have been 90-plus percent, exceeding the industry average of around 65%."[8] After the April 5 investor call, NCI's stock price immediately jumped.

         On April 19, 2017, NCI received an indication that Party A was interested in acquiring NCI for $20 per share, and received updated offers from H.I.G. for $19 per share and Party C for $20 per share. On April 24, 2017, Dillahay and NCI's CFO had a dinner meeting with "Party E," a leading provider of IT services to the United States government, during which they indicated that Party E would need to move quickly if it wished to acquire NCI. Party E submitted a non-binding indication of interest the next day with a price between $18 and $20 per share. During this time period, NCI also received inquiries from "Party B" and "Party D," but talks broke down because Party B held a minority interest in a competitor of NCI and Party D's proposal valued NCI between only $200 million and $235 million.

         During an earnings call on May 9, 2017, Dillahay highlighted "the progress [NCI is] making in implementing [its] strategic turnaround plan" and commented that NCI's pipeline had increased in the past month.[9]

         On May 10 and 11, 2017, NCI hosted presentations for representatives of Parties A, C, E, and H.I.G., after which H.I.G. increased its bid to $20 per share and the remaining parties withdrew from the process. Parties A and C both indicated they were concerned with risks associated with the "recompete process," referring to the Company's ability to win the next contract on a particular project after completing the first contract. Party C also was concerned about the uncertainty of the timing of NCI's strategic turnaround plan, and Party E stated that its calculation of synergies was lower than previously expected and it needed more information to bid.

         E. NCI Grants H.I.G. Exclusivity

         On May 27, 2017, NCI granted H.I.G. exclusivity through June 13, 2017 and agreed to pay H.I.G.'s expenses if NCI pursued an alternative transaction. The exclusivity period was later extended to June 18, 2017 without any additional consideration. H.I.G. was given access to speak directly with some of NCI's customers, without an NCI representative participating on the calls. When the exclusivity period expired, NCI did not try to contact any other potential buyers.

         On June 26, 2017, H.I.G. notified NCI that it was prepared to move forward with acquiring NCI for $20 per share. NCI shares were trading at $21.15 per share at that time. Also on June 26, "a representative of Wells Fargo contacted a representative of H.I.G. to inform it that NCI was proposing transaction and retention bonuses for certain key employees in the aggregate amount of approximately 1.75 million."[10]

         On June 27, 2017, the NCI Board met to discuss H.I.G.'s proposal. During the meeting, Wells Fargo and Stifel presented a summary of their preliminary financial analyses of the H.I.G. proposal. After the meeting, Wells Fargo informed H.I.G. that the aggregate amount of the proposed transaction and retention bonuses NCI intended to make would be $1.25 million, including a $300, 000 bonus for Dillahay.[11] On June 29, 2017, during an NCI Board meeting, Wells Fargo and Stifel discussed their financial analyses of H.I.G.'s proposal and provided fairness opinions on the $20 per share price. During the meeting, the Board voted to enter into the merger agreement.

         F. The Merger Agreement and Tender Offer

         On July 2, 2017, NCI and H.I.G. affiliates Cloud Intermediate Holdings, LLC and Cloud Merger Sub, Inc. executed an Agreement and Plan of Merger (the "Merger Agreement") under which H.I.G., through its affiliates, would acquire all of NCI's outstanding common stock for $20 per share or approximately $283 million in total through an all-cash tender offer to be followed by a merger. On July 3, NCI issued a press release announcing the execution of the Merger Agreement. On June 30, 2017, the last day of trading before the acquisition was announced, NCI's shares closed at $21.20.

         The Merger Agreement contained a number of deal protections, including a "no solicitation" provision that prohibited NCI from soliciting alternative proposals but also contained a "fiduciary out" provision allowing the Board to consider a superior proposal in limited circumstances. The Merger Agreement also contained a matching rights provision and a termination fee of approximately $11 million, representing approximately 4% of the implied enterprise value of the Transaction.[12]

         In connection with the execution of the Merger Agreement, Narang entered into a tender and support agreement to tender all of his shares to H.I.G., and the other directors and certain members of NCI's management indicated that they would tender their shares as well. As a group, these individuals accounted for approximately 35% of the outstanding shares of NCI.

         On July 17, 2017, NCI filed the Recommendation Statement on Schedule 14D-9, and the tender offer commenced. The tender offer expired twenty-five days later, on August 11, 2017. In response to the tender offer, NCI stockholders (including Narang) tendered 11, 924, 366 shares, representing "approximately 82%" of the total shares outstanding.[13] Excluding the shares Narang held and tendered, approximately 73.6% of the outstanding shares were tendered.[14] The merger closed on August 15, 2017, four days after the tender offer expired.


         On March 28, 2018, plaintiffs filed the Complaint, asserting two claims. Count I asserts a claim for breach of fiduciary duties against the individual defendants, contending that they "sanctioned a process and price that was not entirely fair" and "failed to disclose material information."[15] Count II asserts a claim for aiding and abetting against the H.I.G. Defendants.

         On May 14, 2018, defendants filed a motion to dismiss the Complaint in its entirety under Court of Chancery Rule 12(b)(6) for failure to state a claim for relief. The court heard argument on the motion on December 18, 2018.

         III. ANALYSIS

         The standards governing a motion to dismiss for failure to state a claim for relief are well settled:

(i) all well-pleaded factual allegations are accepted as true; (ii) even vague allegations are "well-pleaded" if they give the opposing party notice of the claim; (iii) the Court must draw all reasonable inferences in favor of the non-moving party; and ([iv]) dismissal is inappropriate unless the "plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof."[16]

         Defendants' primary argument for dismissal is based on Corwin v. KKR Financial Holdings LLC[17] and its progeny.[18] Under Corwin, "when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies."[19] "[S]tockholder approval of a merger under Section 251(h) by accepting a tender offer has the same cleansing effect as a vote in favor of that merger."[20] As our Supreme Court has explained:

When the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result. That is because the vestigial waste exception has long had little real-world relevance, because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.[21]

         Defendants argue that plaintiffs have not pled facts sufficient to trigger entire fairness review and that the Transaction is thus subject to the business judgment rule under Corwin because it was approved by a fully informed, uncoerced vote of the disinterested stockholders, i.e., a 73.6% majority of the stockholders other than Narang who tendered their shares in the tender offer. It is not disputed that a majority of disinterested stockholders tendered their shares in connection with the Transaction or that the Transaction was uncoerced.

         Plaintiffs advance essentially two arguments for why Corwin does not apply. First, they argue that entire fairness should apply on the theory that Narang, NCI's controlling stockholder, was conflicted in the Transaction because of his need for liquidity. Second, they argue that the vote was not fully informed based on three alleged deficiencies in the Recommendation Statement. The court addresses each of these arguments in turn below.

         A. The Transaction Is Not Subject to Entire Fairness Review

         Entire fairness is "Delaware's most onerous standard."[22] "Once entire fairness applies, the defendants must establish 'to the court's satisfaction that the transaction was the product of both fair dealing and fair price.'"[23] "[C]ontrolling stockholders are not automatically subject to entire fairness review when a controlled corporation effectuates a transaction. Rather, the controller also must engage in a conflicted transaction for entire fairness to apply."[24] "Conflicted transactions include those in which the controller stands on both sides of the deal"[25]-which does not apply here since a third party acquired all of NCI's shares-and those "where the controller gets a unique benefit by extracting something uniquely valuable to the controller."[26]

         Plaintiffs argue that entire fairness should apply here because "Narang controlled NCI and was conflicted with respect to the Acquisition" in that it afforded him a "unique benefit" to address his "need or desire for liquidity."[27] In support of this argument, plaintiffs rely heavily on this court's decision in N.J. Carpenters Pension Fund v. info GROUP, Inc.[28] Defendants disagree. They contend that "Narang's ownership of NCI stock aligned his interests with other stockholders" and that the Complaint does not plead facts necessary to support entire fairness review under a "need for liquidity" theory.[29] In support of their position, defendants rely heavily on this court's decision in In re Synthes, Inc. Shareholder Litigation.[30] The court begins by discussing the two key cases on which the parties rely before turning to analyze the allegations of the Complaint.

         In info GROUP, a stockholder challenged a third-party acquisition of info GROUP, Inc. that allegedly was orchestrated by the company's founder and 37% stockholder Vinod Gupta "so that Gupta could obtain desperately needed liquidity."[31] The complaint specifically alleged that Gupta "owed over $12 million as a result of [prior] derivative and SEC settlements," had over $13 million of debt from loans used to buy info GROUP stock, "had not received a salary since leaving his job as CEO under the terms of the derivative settlement," "did not hold investments that provided him with 'meaningful cash, '" planned to launch a new business to be funded with his own money, and that the company's board had "repeatedly discussed" his "liquidity problems."[32] The court found that these "well-pleaded facts . . . support an inference that the liquidity benefit received by Gupta was a personal benefit not equally shared by other shareholders" such that he "suffered a disabling interest" as a director with respect to the transaction.[33] Based on this finding, and its inference that Gupta dominated his fellow directors and rendered "them non-independent for purposes of voting on the Merger," the court concluded that plaintiff's loyalty claim stated a claim for relief.[34]

         In Synthes, which was decided one year after info GROUP, the court considered another "liquidity-based" challenge to a third-party acquisition of a company involving a stockholder (Hansjoerg Wyss) who allegedly controlled 52% of the company's shares.[35] Chief Justice Strine, writing as Chancellor, ultimately declined to apply entire fairness review to the transaction and dismissed the complaint for failure to state a claim for relief despite "hints" in the complaint "that as Wyss aged, he was anxious to get out of Synthes and that this anxiety drove the strategic process of the company in a way that was unfair to the minority."[36] In doing so, the court expounded on the type of circumstances where a need for liquidity could create a disabling conflict of interest for a controlling stockholder, as follows:

It may be that there are very narrow circumstances in which a controlling stockholder's immediate need for liquidity could constitute a disabling conflict of interest irrespective of pro rata treatment. Those circumstances would have to involve a crisis, fire sale where the controller, in order to satisfy an exigent need (such as a margin call or default in a larger investment) agreed to a sale of the corporation without any effort to make logical buyers aware of the chance to [buy], give them a chance to do due diligence, and to raise the financing necessary to make a bid that would reflect the genuine fair market value of the corporation.[37]

         With this framework in mind, the court found that "there are no well-pled facts to suggest that Wyss forced a crisis sale of Synthes to J & J in order to satisfy some urgent need for cash," noting plaintiff's failure to allege facts suggesting that Wyss had tried to sell his stock "in whole or in substantial part" after stepping down as CEO, that Wyss (rather than the board) initiated the sale process, or that the process was rushed or unreasonably restricted.[38]

         In my opinion, the alleged facts here are similar to those pled in Synthes and bear no resemblance to those pled in info GROUP. As discussed next, the Complaint contains no concrete facts from which it reasonably can be ...

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