Breach of Fiduciary Duty Suits Arising Out of Yahoo’s Rejection of Microsoft’s Offer

Last month, Yahoo!, the California-based Internet service provider, rejected a “generous” offer by U.S. software giant, Microsoft. [1] Microsoft’s 62 percent premium above Yahoo!’s share was aimed at maximizing synergies that existed between both companies. Microsoft hoped to gain a greater market advantage in the internet search industry while enjoying a majority share of the projected $80 billion market by year 2010. [2] Following Yahoo!’s rejection, some disgruntled Yahoo shareholders have sought legal remedies to voice their dissatisfaction with Yahoo’s decision. [3] In light of three previously decided cases, Emerging, Van Gorkom, and Disney, this article will attempt to provide a legal analysis on the breach of fiduciary duty suits against Yahoo!.

 

Emerging Communication

 

In Emerging Communication, the court addressed, inter alia, class action claims for breach of fiduciary duty. The court held that the defendants in question were jointly and severally liable to the plaintiff class in an amount equal to $27.80 per share. [4]

 

Emerging Communications, Inc. (“ECM”) and Atlantic TeleNetwork (“ATN”) were telecommunications companies formed by Jeffrey J. Prosser (“Prosser”) and a partner, Cornelius Prior (“Prior”), to acquire the Virgin Islands Telephone Corporation (“Vitelco”). [5] Vitelco operated solely in the U.S. Virgin Islands and was attractive for several reasons. Vitelco’s operational market was not saturated with competitors and as such was guaranteed an 11.5% rate of return on the rate base for the local telephone service. [6] In addition, Vitelco had access to below-market interest rate loans. [7] Moreover, The USVI Industrial Development Commission (“IDC”) granted Vitelco numerous tax incentives which made the company in essence free from taxation. [8] Several years later, Prosser and Prior’s business relationship crumbled –this precluded Prosser’s acquisition strategy. [9] The crumbled relationship led to the breakup of Prosser and Prior’s joint companies, leaving Prosser with 52% of ECM's 10,959,131 shares. ECM's public shareholders were relegated to the position of minority stockholders. [10] The breach of fiduciary duty actions herein arose out of a two-step “going private” acquisition of the publicly owned shares of ECM by another company, Innovative Communications Company:

The first step tender offer was commenced on August 18, 1998 by Innovative for 29% of ECM's outstanding shares at a price of $10.25 per share. The balance of ECM's publicly held shares were acquired in a second-step cash-out merger of ECM into an Innovative subsidiary, at the same price, on October 19, 1998. At the time of this two-step transaction (the "Privitization"), 52% of the outstanding shares of ECM, and 100% of the outstanding shares of Innovative, were owned by Innovative Communication Company, LLC ("ICC"). ICC, in turn, was wholly owned by ECM's Chairmand and Chief Executive Officer, Jeffrey J. Prosser ("Prosser"). Thus, Prosser had voting control of both of the parties to the Privitization transaction. [12]

In connection with the two-step transaction, stockholders of ECM filed fiduciary actions suits claiming, inter alia, that Prosser’s acquisition strategy of ECM was unfair. As part of Prosser’s strategy, the remainder 48% shares (Prosser owned 52% shares) were to be purchased at $10.25 per share. [13] The Court of Chancery found that the consideration paid to the shareholders was unfair because the fair market value of ECM’s stock was $38.05, almost four times the amount paid. [14] The Court having concluded that the transaction was unfair, proceeded to assess liability of Prosser and the other ECM’s directors. Some, but not all defendants, were found to have breached their duty of loyalty and/or good faith. [15] The “and/or” phraseology was used because the Delaware Supreme Court has yet to articulate the precise distinction between the duties of loyalty and of good faith. [16] To that end, the court stated that if a loyalty breach requires that the fiduciary have a self-dealing conflict of interest in the transaction itself, then only Prosser should be liable. Although the Supreme Court has yet to define the precise conduct that is actionable under a breach of good faith, the Emerging Court held that the directors could be found to have violated their duty of good faith if they consciously and intentionally disregard their responsibilities, adopting a ‘we don’t care about the risks’ attitude concerning a material corporate decision.” [17]

Van Gorkom

 The next case is Smith v. Van Gorkom. Here, the Court of Chancery held defendant directors' decision to approve a merger was not the product of an informed business judgment, that efforts to amend the merger agreement were ineffectual, and that defendant directors had not disclosed all material facts to the stockholders. [18] In Van Gorkom, plaintiffs contended that defendant’s decision to approve a cash-out merger of their corporation did not warrant business judgment rule protection. The court agreed, stating that the business judgment rule, in part, provides that directors of a corporation must act on an informed basis, in good faith, and in the honest belief that the action taken was in the best interest of the company when making business decisions. [19] Further, it has been an uncontested standard of review that “a director's duty to inform himself in preparation for a decision derives from the fiduciary capacity in which he serves the corporation and its stockholders.” [20] In the specific context of a proposed merger of domestic corporations, a director has a duty under 8 Del.C. § 251(b) (Merger or consolidation of domestic corporations), along with his fellow directors, to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders. [21] The director’s duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyalty. The former duty requires a director to take an active and direct role in the context of a sale of a company from beginning to end. [22]

Disney

Lastly, a $140 million executive compensation and severance package of former Walt Disney Company President Michael Ovitz was the basis for the breach of fiduciary duty suit against Disney’s officers and directors. [23] Shortly after Ovitz joined Disney, it became apparent that there was a “disconnect” between himself and other Disney officers. [24] A year after Ovitz was hired, he was informed by the then Walt Disney’s general counsel Michael Eisner that he would be terminated without cause. [25] Pursuant to the facts, Ovitz had done nothing to warrant termination and the corollary, stated in Ovitz’s contract, was for Disney to pay him a substantial severance package in a no-fault termination. [26] Shortly after Ovitz received his severance package, a number of derivative actions followed. Plaintiff’s claim, inter alia, was that Disney’s board of directors breached their fiduciary duties of care and good faith by paying $140 million to Ovitz. – They felt that the pay-out constituted corporate waste. [27] The court rejected Plaintiffs’ contention that Disney’s board breached their fiduciary duties. The Court held that defendants’ conduct was protected by the business judgment rule. The Court reasoned that under the well-settled Delaware rule, the business judgment rule affords directors of corporations the presumption that their actions were based on information and that they were taken in the best interest of the corporation and its stockholders. [28] The Court further noted that the said presumption is rebutted when the board violates one of its fiduciary duties. [29]. Citing Emerging, this court held that liability must still be determined on an individual basis. [30] The concept of duty of good faith is an evolving issue and hence the Courts have yet to draw a meaningful distinction between a fiduciary duty of good faith and what good faith is. [31] However, this court has enumerated three instances when a director has failed to act in good faith: “(1) where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, (2) where the fiduciary acts with the intent to violate applicable positive law, and (3) where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.” [32] The Court ultimately concluded that Eisner’s actions were taken in good faith. Neither Eisner nor any of the other directors stood to benefit from Ovitz’s termination as such the Court found that there was no reason to think that the directors were incapable of exercising business judgment. Thus, the decision to terminate Ovitz warranted judicial protection.

Last month, two class action suits were filed in the Delaware Court of Chancery against the directors of Yahoo! for breach of fiduciary duties in relation to Yahoo’s rejection of Microsoft’s offer. Microsoft’s offer reflected a 62 percent premium above Yahoo! share value. [33] The first and second complaints are Wayne County Employees’ Retirement Sys. v. Yahoo!, Inc.  and Police and Fire Retirement System of the City of Detroit et al. v. Yahoo!, Inc.. The second complaint alleges that Yahoo!’s board members “placed personal distaste for Microsoft ahead of shareholder welfare” and have breached their fiduciary duties by rejecting Microsoft’s value-maximizing offer. [34] The complaints filed against Yahoo! are best understood in the light of Emerging, Van Gorkom, and Disney. In order to articulate how effective a suit against Yahoo! may be, it is imperative to understand the rationale behind Yahoo!’s decision to reject Microsoft’s offer and the various roles each executive board member played. In Emerging, Prosser was found to have breached his fiduciary duty because he stood on both sides of the transaction – a transaction that would ultimately lead him to reap enormous benefits at the expense of the minority shareholders. The Court used “fairness” as a standard of review. In Van Gorkom, the standard of review used was based on the directors’ duty to make an informed business making decision. [35] The Disney Court found that neither Eisner nor the other Disney directors were self-interested in the $140 million payout to Ovitz; as such, the business judgment rule was the standard of review. [36]

In a letter in response to Microsoft’s offer, Yahoo! wrote:

“After careful evaluation, the Board believes that Microsoft’s proposal substantially undervalues Yahoo! including our global brand, large worldwide audience, significant recent investments in advertising  platforms and future growth prospects, free cash flow and earnings potential, as well as our substantial unconsolidated investments. The Board of Directors is continually evaluating all of its strategic options in the context of the rapidly evolving industry environment and we remain committed to pursuing initiatives that maximize value for all stockholders.” [37]

Following this letter, the suits filed against Yahoo! have alleged, inter alia, a breach of Yahoo!’s fiduciary duty. In summary, the complaints allege that Microsoft’s offer was fair, generous, and ultimately a maximization of the shareholder’s value. In other words, Yahoo!’s rejection was tantamount to a breach of its fiduciary duty.

In defense to the complaints, Yahoo! could contend that its board members informed themselves prior to rejecting Microsoft’s offer and they considered all relevant material information reasonably available to them. Furthermore, Delaware Law provides protection for directors of a corporation if they relied in good faith in reports by officers. In this case, Yahoo utilized independent legal and financial resources in evaluating Microsoft’s offer. According to Bloomberg, financial advisors at Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and lawyers at Skadden, Arps, Slate, Meagher & Flom LLP were among the disinterested parties that led Yahoo! to ultimately reject Microsoft’s offer.[38]  The Corporate Accountability Report which “shed[s] new light on corporate lawyers' changing roles and responsibilities and myriad high-profile challenges,” suggested that liability can be avoided by non self-dealing transactions, employing arms-length negotiations, and selecting disinterested parties in evaluating an offer.

Yahoo! could also contend that Yahoo CEO Jerry Yang and Yahoo!’s board members acted on an informed basis, in good faith, and in honest belief that Microsoft’s offer was not in the best interest of the company. These elements may be hard to prove since, over the past year, Yahoo has been in financial difficulties. A recent report indicated that Yahoo needed to lay up to 1,000 workers, [39] to remain profitable.

Although, Yahoo may have had a logical and deductive process in turning down the offer, Yahoo!’s board members need to find a convincing story to tell shareholders.  This is extremely important because with Yahoo!’s board members up for re-election this month, Microsoft “reserves the right to pursue all necessary steps to ensure that Yahoo!’s shareholders are provided with the opportunity to realize the value inherent in [Microsoft’s] proposal.” [40] 

[1] Ari Levy, Microsoft Offers to Buy Yahoo for $44.6 Billion, Bloomberg, Feb. 9, 2008, http://www.bloomberg.com/apps/news?pid=20601087&sid=ayQKSxvKatQs&refer=home.

[2] Id.

[3] Delaware Business Litigation Report, http://www.delawarebusinesslitigation.com/(Feb. 22, 2008).

[4] In re Emerging Communications, Inc. Shareholders Litigation, No. Civ.A. 16415, 2004 WL 1305745, at *43 (Del. Ch. June 4, 2004).

[5] Id. at *3.

[6] Id.

[7] Id. at *4.

[8] Id.

[9] Id.

[10] Id.

[11] Id. at *1.

[12] Id.

[13] Id.

[14] Id. at *43.

[15] Id.

[16] Id. at *39.

[17] Id. at *43.

[18] Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).

[19] Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984).

[20] Van Gorkom, 488 A.2d at 872.

[21] Id. at 873.

[22] In re Emerging Communications, Inc. Shareholders Litigation, 2004 WL 1305745, at *42.

[23] In re Walt Disney Company Derivative Litigation, 907 A.2d 693, 710 (Del. Ch. 2005).

[24] Id. at 714-16.

[25] Id. at 728-29.

[26] Id.

[27] Lewis H. Lazarus and Joseph S. Naylor, Bureau of Nat’l Affairs, Inc., Corporate Accountability Report, Emerging Trends in Fiduciary Duty Litigation: Lessons Learned from Emerging Communications and Disney (Mar. 31, 2006).

[28] Id.

[29] Id.

[30] Id.

[31] Id.

[32] Id.

[33] Delaware Business Litigation Report, supra note 3.

[34] Id.

[35] Van Gorkom at 872.

[36] Lazarus and Naylor, supra note 27.

[37] Erick Schonfeld, Yahoo Confirms Rejection Letter to Microsoft, Feb. 11, 2008, http://www.techcrunch.com/2008/02/11/yahoos-rejection-letter-to-microsoft/.

[38] Ari Levy, supra note 1.

[39] Michael Liedtke, Yahoo to Lay Off 1,000 Workers, Jan. 29, 2008, http://biz.yahoo.com/ap/080129/earns_yahoo.html.

[40] Glenn Chapman, Microsoft Renews Bid Despite Yahoo Rejection, Feb. 12. 2008, http://news.yahoo.com/s/afp/20080212/bs_afp/usitcompanytakeovermicrosoftyahooreject 

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