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IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
IN AND FOR NEW CASTLE COUNTY
)
IN RE: DIGEX, INC. ) Consolidated
SHAREHOLDERS LITIGATION ) Civil Action No. 18336
)
-----------------------------------------
O P I N I O N
Date Submitted: December 4, 2000
Decided: December 13, 2000
Stuart M. Grant, Megan D, McIntyre, and Jeffrey D. Hofferman, of GRANT &
EISENHOFER, P.A., Joseph A. Rosenthal, of ROSENTHAL MONHAIT GROSS & GODDESS,
P.A., and Pamela S. Tikellis, of CHIMICLES & TIKELLIS, Wilmington, Delaware; OF
COUNSEL: DANIEL C. GIRARD, OF GIRARD & GREEN, LLP, San Francisco, California;
and James S. Notis, of ABBEY, GARDY & SQUITIERI, LLP, New York, New York;
Attorneys for Plaintiffs.
Robert K. Payson and Stephen C. Norman, of POTTER ANDERSON CORROON LLP,
Wilmington, Delaware; OF COUNSEL: Brian J. Gallagher and John A. Morris, of
KRONISH LIEB WEINER & HELLMAN LLP, New York, New York, Attorneys for Defendants
Intermedia Communications Inc., John C. Baker, Philip A. Campbell, George F.
Knapp, Robert M. Manning, and David C. Ruberg.
Henry E. Gallagher, Jr. and Collins J. Seitz, of CONNOLLY BOVE LODGE & HUTZ LLP,
Wilmington, Delaware; OF COUNSEL: Brian J. McMahon and Stephen R. Reynolds, of
GIBBONS, DEL DEO, DOLAN, GRIFFINGER & VECCHIONE, Newark, New Jersey, Attorneys
for Defendant WorldCom, Inc,
William O. LaMotte, III, of MORRIS NICHOLS ARSHT & TUNNELL, Wilmington,
Delaware; OF COUNSEL: Kevin M. McGinty, of MINTZ LEVIN COHN FERRIS GLOVSKY AND
POPEO, Attorneys for Digex, Inc.
CHANDLER, Chancellor
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TABLE OF CONTENTS
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I. FACTUAL AND PROCEDURAL HISTORY.......................................................................... 3
A. Intermedia investigates strategic alternatives................................................. 3
B. Digex appoints a Special Committee............................................................. 7
C. WorldCom enters the fray....................................................................... 9
D. The deal changes............................................................................... 10
E. The Special Committee's morning caucuses....................................................... 12
F. The Intermedia board meeting................................................................... 14
G. The Digex board meeting........................................................................ 15
H. Procedural History............................................................................. 16
II. STANDARD FOR A PRELIMINARY INJUNCTION................................................................... 17
III. THE CORPORATE OPPORTUNITY CLAIM......................................................................... 18
A. Summary of the Arguments....................................................................... 18
B. Legal Analysis................................................................................. 20
1. Why Digex had no "interest or expectancy" in a
WorldCom-Digex deal................................................................... 21
2. Did defendants breach their duty of loyalty in negotiating the
WorldCom-Intermedia deal?............................................................. 25
3. Are the defendants estopped from completing a WorldCom-
Intermedia deal?...................................................................... 31
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4. Is this a Revlon case? .......................................... 33
IV. SECTION 203 CLAIM....................................................................................... 36
A. Does the 85% exemption apply to WorldCom?...................................................... 38
B. Is This Claim Ripe for Adjudication?........................................................... 53
C. Was the Section 203 Waiver Entirely Fair to the Digex Shareholders?............................ 55
1. Fair Dealing.......................................................................... 58
2. Fair Price............................................................................ 66
V. THREAT OF IRREPARABLE HARM
AND BALANCING OF THE POTENTIAL HARM..................................................................... 73
VI. CONCLUSION.................................................................................................. 76
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This is my decision on plaintiffs' motion to preliminarily enjoin the
proposed merger between defendants WorldCom, Inc. ("WorldCom") and Intermedia
Communications, Inc. ("Intermedia"), the controlling shareholder of Digex, Inc.
("Digex").(1) Plaintiffs, minority shareholders of Digex, seek either of two
alternative forms of relief: (1) an order enjoining the defendants from
consummating the Agreement and Plan of Merger dated September 1, 2000 (the
"merger"), or (2) an order enjoining the Digex board's waiver of 8 Del. C
Section 203. Intermedia's shareholders are tentatively scheduled to vote on the
proposed merger on December 18, 2000.
The allegations in plaintiffs' consolidated complaint are founded on
two distinct legal theories. Plaintiffs' first theory is that defendants usurped
a corporate opportunity that (allegedly) fairly belonged to Digex by preventing
Digex's sale to the highest bidder. Plaintiffs' second theory is that the Digex
board, more specifically the four interested Digex directors, breached a
fiduciary duty when they voted to waive the protections afforded Digex by
Section 203 of the Delaware General Corporate Law ("DGCL").
At the outset it is important to recognize the highly unusual
circumstances surrounding the pending request for injunctive relief. The
plaintiffs have asked, in the context of a preliminary injunction, for relief
that is both prospective and retrospective. Specifically, the plaintiffs seek
either a preliminary injunction against the future consummation of a merger (via
a claim of usurpation of corporate opportunity) or,
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(1) In this Opinion, where I use the term "defendant" or "defendants," I am
referring to Intermedia and its agents. Where, however, I intend to refer
to defendant WorldCom, I will refer to it specifically.
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alternatively, a preliminary decision that declares invalid or ineffective a
past act of the Digex board to waive the protections afforded under 8 Del. C
Section 203.
For the reasons discussed more fully below, the plaintiffs have not
persuaded me that they have a likelihood of success on the merits of their
corporate opportunity claim. On the other hand, they have shown a likelihood of
success on the merits of their Section 203 claim. In the course of analyzing the
merits of the Section 203 claim, however, it becomes abundantly clear that no
injunctive order is necessary to protect plaintiffs from a future act or
decision that threatens immediate irreparable harm. That is because the Section
203 claim is based on a past decision or action from which the harm has already
occurred. Any injury based on the Section 203 claim has resulted not from
pending action, but from action past--by the faithless acts of the four
Intermedia directors who voted to waive Section 203's protections. There is no
prospective harm that could be avoided by the application of a preliminary
injunction. Thus, any relief must be remedial, rather than injunctive. The
Court's determination that plaintiffs have a likelihood of success on their
Section 203 claim means that the parties to the merger-Intermedia and
WorldCom-must decide whether to proceed with that transaction knowing that this
Court has preliminarily determined that Digex's Section 203 waiver will not
likely be effective in the circumstances of this case. For this reason as well,
no basis exists for injunctive relief based on the Section 203 claim, because
the plaintiffs' ultimate success on the merits of that claim will have the
practical effect of restoring to the Digex minority shareholders the protection
to which they were entitled under Section 203.
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Notwithstanding the unusual posture in which the request for injunctive
relief is presented to the Court, I will address the application in the typical
fashion of a motion for a preliminary injunction. In Part I of this Opinion I
set forth the factual and procedural history relevant to the resolution of
plaintiffs' motion. Part II describes the applicable standard for preliminary
injunctive relief. In Part III, I address plaintiffs' corporate opportunity
claim, while Part IV considers plaintiffs' alternative Section 203 claim. Part V
considers the irreparable harm and balance of the equity prongs of the
preliminary injunction standard. Finally, Part VI sets forth my conclusions.
I. FACTUAL AND PROCEDURAL HISTORY(2)
A. Intermedia investigates strategic alternatives
Intermedia and Digex are both Delaware corporations. Intermedia is an
integrated communications provider delivering local, long distance, and enhanced
data services, principally to business and governments. Digex provides managed
web hosting and application hosting services primarily to large corporate
clients. Intermedia has held a controlling interest in Digex since July 1997.
Following public offerings in August 1999 and February 2000, Intermedia now owns
52% of Digex's outstanding stock which represents approximately 94% of the
voting power of all of Digex's outstanding stock.(3)
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(2) Most of the facts set forth here are not in dispute and were taken from the
consolidated complaint and the briefs of the parties. Where facts are in
dispute, I have cited to the specific deposition, affidavit, or other
document that formed the basis for the particular statement.
(3) Consolidated Compl., at 3. Digex's capital structure consists of two
classes of stock. Class A is entitled to one vote per share, and Class B is
entitled to 10 votes per share. Intermedia holds 39,350,000 Class B shares.
There are 24,150,000 Class A shares outstanding.
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During the time periods relevant to this case, Digex's board of
directors had eight members, five of which-David C. Ruberg, Robert M. Manning,
Philip A. Campbell, John C. Baker, and George F. Knapp-were also officers or
directors of Intermedia.(4) The interested directors stood to personally profit
tremendously upon a sale of Intermedia, but to profit very little, or not at
all, upon a sale of Digex.(5) The remaining three directors-Jack E. Reich,
Richard A. Jalkut, and Mark K. Shull-were not affiliated with Intermedia.
Digex is well positioned in one of the hottest segments of the
technology sector-web hosting. Intermedia, however, is in poor financial
condition.(6) Since early 1999, Intermedia has been considering strategic
options to maximize the value of both itself and Digex, including the possible
sale of itself or its various holdings. This effort continued in earnest in June
2000, following the NASDAQ downturn. At this time, it was apparent to Intermedia
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(4) Due to health problems, Knapp was not involved in the events that
culminated with the WorldCom-Intermedia merger agreement.
(5) Ruberg owns 1,057,839 Intermedia shares but no Digex shares. Manning owns
255,731 Intermedia shares but no Digex shares. Campbell owns 28,000
Intermedia shares and 13,334 Digex shares. Baker owns 81,820 Intermedia
shares and 13,334 Digex shares. See Pls.' Ex. 19 (Digex April 27, 2000,
Proxy Statement) at 18-20. In addition, Ruberg and Manning owned Intermedia
employee stock options that would be accelerated by an Intermedia deal but
not by a Digex deal. See Pls.' Ex. 27 (S-4) at 38. Similarly, Ralph
Sutcliffe of Kronish Lieb Weiner & Hellman LLP, outside counsel to both
Intermedia and Digex, would receive a multi-million dollar payment in the
event of an Intermedia deal, but collect nothing in the case of a Digex
deal. See Pls.' Ex. 27 (S-4) at 37.
(6) In the spring of 2000, Intermedia had significant debt and its second
quarter losses exceeded those projected by Wall Street analysts. If
Intermedia did not receive a substantial cash infusion by the end of 2000,
it faced financial crises. See Shull Dep. at 11, 14; Decker Dep. at 10;
Manning Dep. at 27-28.
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that it would be difficult to arrange financing to fund Digex and Intermedia on
a long-term basis, a prospect that threatened the survival of both corporations.
Thus, on June 29, Intermedia hired Bear Stearns & Co. ("Bear Stearns") to
explore all possible strategic alternatives.(7) On this same day, Intermedia
informed the Digex board that it planned to explore the feasibility of a sale of
its equity interest in Digex. On July 11, Intermedia issued a press release
announcing that they had retained Bear Stearns to explore Intermedia's strategic
alternatives with regard to Digex, including the possible sale of Intermedia's
ownership position in Digex to another company.
In July, Bear Stearns approached WorldCom about potential strategic
alternatives concerning Intermedia and Digex. A deal involving Intermedia
presented an opportunity for WorldCom on two fronts. First, Intermedia has a
presence in the Competitive Local Exchange Carrier (CLEC) market and WorldCom
could acquire these CLEC assets. Second, through Digex, WorldCom could expand
its presence in the critical web-hosting arena.
WorldCom was not the only potential suitor for Intermedia approached by
Bear Stearns. During July and August, Bear Stearns contacted thirty likely
suitors for Intermedia or Digex, received expressions of interest from thirteen,
sent confidentiality agreements to
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(7) Plaintiffs stress that Bear Stearns had a financial incentive to sell
Intermedia, as opposed to merely selling Digex because the terms of the
retention agreement between Bear Stearns and Intermedia provided that Bear
Stearns would receive $22 million if it sold Intermedia, but only $15
million if it sold Digex. See Pls.' Ex. 15 (Retainer Letter of Bear
Stearns) at 4.
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ten, and received executed non-disclosure agreements from, and sent materials
to, six.(8) Ultimately, three suitors emerged: Exodus Communications Inc.
("Exodus"), Global Crossing, Ltd. ("Global Crossing"), and WorldCom.
Though Global Crossing was involved up until the end,(9) WorldCom would
prove to be the successful suitor.(10) As early as July 17, a junior member of
WorldCom's corporate development team prepared a presentation analyzing four
possible alternative transactions among WorldCom, Digex, and Intermedia. On or
about August 2, the corporate development department put together a formal
presentation package concerning opportunities in the web hosting field,
including a detailed discussion of Intermedia and Digex-together and
individually-as potential acquisition targets for WorldCom. During this same
period, WorldCom was also negotiating a possible joint venture in the web
hosting arena with Global Crossing, but these talks ended when WorldCom
discovered that Global
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(8) WorldCom, through William Grothe, Vice President of Corporate Development,
signed a non-disclosure confidentiality agreement and obtained confidential
business information packages from Bear Stearns on both Intermedia and
Digex, including financial projections for both companies. Digex was
required to provide this confidential information at the request of
Intermedia.
(9) As the following facts will explain, Global Crossing made an offer for
Intermedia that remained on the table until September 1 at 5 p.m. Though
given the opportunity, it did not bid against WorldCom when WorldCom came
on the scene on August 30-31.
(10) Negotiations with Exodus during July and August ultimately failed because,
according to Intermedia, "Intermedia and Exodus could not agree on the
restrictions on Intermedia's ability to sell the Exodus shares it would
receive for its Digex stock in order to comply with the covenants in its
bond indentures." Def. Intermedia's Br., at 6.
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Crossing had simultaneously been negotiating a three-way merger with Intermedia
and Digex. By the end of August, WorldCom had focused on Intermedia and Digex.
B. Digex appoints a Special Committee
The directors of Intermedia and Digex understood from the beginning of
this process undertaken by Bear Stearns that conflicts of interest might arise
between the two companies. Put simply, Digex was a rapidly growing company that
was extremely attractive to potential suitors. As stated above, Intermedia had
severe financial problems. In fact, as of August, Intermedia's equity holdings
in Digex exceeded Intermedia's total market capitalization. Intermedia and its
banker, Bear Stearns, had three possible avenues before it. Intermedia could
sell itself, could sell its holdings in Digex, or could sell part or all of both
companies.
If Intermedia sold itself (which, of course, would include its majority
stake in Digex), Intermedia's shareholders stood in a position to reap a
substantial premium on their shares, largely due to the acquiror's presumable
desire to obtain control over Intermedia's "crown jewel," Digex. This was
especially true with regard to Intermedia's officers and directors, who, as
discussed above, stood to profit tremendously from a sale of Intermedia. In
contrast, Digex's shareholders stood to gain comparatively little under this
possibility, at least in the short term, other than a new controlling
shareholder.
If Intermedia sold part or all of its Digex holdings, Intermedia could
expect a significant payoff to fund its own operations, but Intermedia's
shareholders, and especially its officers and directors, would not personally
benefit to the extent they would if Intermedia itself were sold. Under this
possibility, Digex shareholders could expect to reap a significant
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premium if Intermedia sold its holdings to an acquirer who decided to then
tender for all outstanding Digex shares.
These various options and possibilities clearly presented the potential
for conflicts of interest for the interested Digex directors, both due to their
dual directorships and their direct, personal financial interests in any
potential transaction. Thus, on July 26, 2000, the Digex board of directors
appointed a special committee (the "Special Committee") comprised of two of the
three independent Digex directors-Jalkut and Reich. Their role was "to
participate in the transaction process and make recommendations to the full
board of directors on matters where there could be a perceived conflict of
interest between Intermedia and Digex."(11) The Special Committee had its own
legal counsel, James Clark of Cahill Gordon & Reindel ("Cahill"), and its own
financial advisors, Credit Suisse First Boston ("CSFB"). The Special Committee
appeared to have authority. In the end, however, the Special Committee could not
stop Intermedia's decision to sign an agreement on September 1 to merge with
WorldCom, even though the Committee believed other potential transactions were
better for Digex.
The true extent of the Special Committee's authority was evident as
early as August, before WorldCom came on the scene. The Special Committee was
involved primarily with the Exodus transaction during July and August. On August
21 the Special Committee arrived at the Digex board meeting prepared to vote on
an Exodus transaction, but learned
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(11) Pls.' Ex. 17 (minutes of July 26, 2000, Digex board meeting) at 2.
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when it arrived that such a transaction would not be presented for a vote.(12)
Instead, the Special Committee learned that negotiations were underway with
Global Crossing.
C. WorldCom enters the fray
Although WorldCom had conducted internal evaluations regarding a
possible transaction with either Intermedia or Digex as early as July, these
evaluations did not result in any action until August 30. On that day, WorldCom
began to seriously consider a bid for control of Digex. Almost exactly
forty-eight hours would elapse between WorldCom's first contact, a call from its
banker to Bear Stearns late on August 30, and the Intermedia board's approval of
the WorldCom-Intermedia merger late in the afternoon on September 1.
Those forty-eight hours began on August 30 between 6:00 and 7:00 p.m.
when Scott Miller of Salomon Smith Barney & Co. ("Salomon"), WorldCom's bankers,
called Andrew Decker of Bear Stearns with an expression of interest to acquire
Digex at $120 a share or more. Miller told Decker that WorldCom would outbid
anyone for Digex. After speaking with Intermedia's negotiators, Decker informed
Miller that WorldCom would have to move quickly. WorldCom did just that. Through
various phone calls that evening, WorldCom decided to send a due diligence team
to New York the following day in order to negotiate a transaction. Sutcliffe
sent a draft merger agreement, which was only for a direct acquisition of Digex,
to WorldCom's counsel, Cravath, Swaine & Moore ("Cravath").(13)
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(12) Exodus had rejected Intermedia's counteroffer and negotiations had ended.
(13) It is disputed whether at this time WorldCom was considering a transaction
other than the direct acquisition of Digex. Defendants claim this was only
one of three template agreements that had been prepared in early August;
the other two were for an Intermedia merger and a sale of Intermedia's
interest in Digex. See Def. Intermedia's Br. at 10.
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Late in the evening of August 30, around 11:00 p.m., Ruberg telephoned each of
the Special Committee members and informed them that WorldCom had offered $120
per share for Digex.
Global Crossing still had an outstanding offer at this point and was
working toward a September 1 signing. On the morning of August 31, Sutcliffe and
Decker told Global Crossing that there was another suitor for Digex-WorldCom.
Global Crossing decided not to bid against WorldCom but continued working toward
its September 1 target.
The WorldCom due diligence team arrived at Sutcliffe's office in New
York on August 31, sometime shortly after noon. There, they met with various
senior executives from Digex and discussed numerous operational issues regarding
Digex. At one point, William Grothe, Vice President of Corporate Development for
WorldCom, Sutcliffe, Ruberg, Decker, and another Bear Stearns representative met
separately to discuss Intermedia's concern that the transaction was not moving
quickly enough. These men testified that both before and during this private
meeting, the only deal that was being discussed was WorldCom's direct
acquisition of Digex.(14)
D. The deal changes
After this private meeting, Bernard Ebbers, WorldCom's President, and
Grothe had several phone conversations. Grothe testified that at about 5:00 p.m.
on August 31, Ebbers
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(14) See Sutcliffe Dep. at 208; Decker Dep. at 222; Grothe Dep. at 140-42.
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told him that WorldCom was going to purchase all of Intermedia rather than
Digex.(15) In the late afternoon of August 31, Ebbers called and left a message
for Decker, who returned the call at about 6:00 p.m. A series of calls ensued.
First, Decker spoke with Ebbers and Scott Sullivan, WorldCom's CFO. During this
call, Ebbers asked Decker if it were possible for WorldCom to leave Digex
outstanding as a public company and buy Intermedia.(16) Decker consulted with
Intermedia and then called Ebbers to inform him that Intermedia would entertain
an offer at $39 a share in WorldCom stock. Ebbers conditionally approved an
acquisition of Intermedia at $39 a share in WorldCom stock.(17) Sutcliffe
notified Clark, legal counsel to the Special Committee, of the change, and Clark
informed the Special Committee. Ruberg informed Shull, Digex's President and
CEO, and Timothy Adams, Digex's CFO. Clark and Sutcliffe had several phone
conversations that evening regarding the Special Committee's "belief or fear"
that Intermedia had manipulated WorldCom's interest from Digex to
Intermedia.(18) Sutcliffe denies such manipulation.(19)
During the night and morning of August 31-September 1, Intermedia and
WorldCom negotiated the merger and WorldCom conducted abbreviated due diligence
of Intermedia. Sutcliffe suggested that WorldCom should make a tender offer for
the Digex public shares,
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(15) See Grothe Dep. at 179-180.
(16) See Decker Dept. at 226-28, 263-67; Ebbers Dep. at 45-59, 94-95.
(17) See Decker Dep. at 229-32; Ebbers Dep. at 49-55, 94-95.
(18) See Sutcliffe Dep. at 226-27, 229.
(19) Id. at 228-29.
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but WorldCom refused.(20) Also during these negotiations, WorldCom first
expressed its interest in receiving the waiver of Section 203 from the Digex
board. Intermedia agreed to seek this waiver, but requested, and received in
return, an agreement to amend the Digex certificate of incorporation to require
independent director approval of any material transaction between WorldCom or
its affiliates.(21) On September 1, Sutcliffe asked Grothe to be sure to address
the Special Committee's possible fear that Intermedia had caused WorldCom to
shift its interest from Digex to Intermedia.(22)
E. The Special Committee's morning caucuses
Up until this point, the Special Committee had not been intimately
involved with the proposed WorldCom-Digex transaction. Until the late evening of
August 31, the Special Committee had been led to believe WorldCom was buying
Digex. Now, the Committee members knew the deal had changed and, once again, it
had changed without their consultation. This had happened just the morning
before at the August 31 Digex board meeting, when the Special Committee members
were informed, much to their surprise, that the Global Crossing-Digex
transaction had been changed to a WorldCom-Digex transaction.
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(20) See id. at 223-26.
(21) See id. at 241-5; Manning, 235-36.
(22) See Grothe Dep. at 218-19; Kindler Dep. at 32. Pursuant to
this call, Grothe made notes that said, in part "Intermedia
talked us into switching offer" and "take public out."
Plaintiffs point to these notes as evidence that Intermedia
did, in fact, talk WorldCom into switching their offer. Grothe
explains that the notes reflected Sutcliffe's earlier advice
that the Special Committee suspected that Intermedia had
caused WorldCom to switch from Digex to Intermedia and he
should be prepared to address that issue in the upcoming
telephone calls. Grothe 218-19. See also Grothe Aff. at 10-11.
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Thus, on the morning of September 1, the Special Committee, Jalkut and
Reich, met with their lawyer, Clark, and Shull and Adams, for a breakfast
meeting around 7:00 a.m. to discuss their options. Specifically, they asked
Clark for his legal opinion regarding the validity of the switch to the
WorldCom-Intermedia merger that was currently being negotiated from the Digex
sale they preferred. Clark responded that they could not force WorldCom to make
a bid for Digex itself.(23) Clark also stated that he believed that legal
opinion was divided on the applicability of Section 203.(24) Clark had concerns
both about the process, especially the circumstances surrounding the mid-stream
switch from a Digex to an Intermedia deal, and about whether the Special
Committee had been kept fully informed.(25)
Shull, Jalkut, and Reich devised a strategy of proposing a mini-auction
at the Digex board meeting later that day because they all believed the proposed
WorldCom-Intermedia transaction was the worst of the three possible deals for
Digex.(26) Shull admits, however, that he saw some concrete benefits to Digex of
a WorldCom-Intermedia merger, including the availability of WorldCom's global
network and facilities.(27)
Next, the Special Committee met with Ruberg who reported the sequence
of events culminating in WorldCom's offer for Intermedia. According to Jalkut,
Ruberg assured the
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(23) See Shull Dep. at 131-34, 37, 161-53; Reich Dep. at 50-55;
Jalkut Dep. at 90-91.
(24) See Shull Dep. at 163-64.
(25) See id. at 131-34, 37, 161-63; Reich Dep. at 50-55; Jalkut
Dep. at 90-91.
(26) See Reich Dep. at 146-47. Accord Jalkut Dep. at 96-97.
(27) See Shull Dep. at 235-39.
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Special Committee that the deal was in the best interests of both Intermedia and
Digex.(28) No mention was made during this meeting of the Section 203 waiver
issue.
Finally, the Special Committee met with its financial advisors, CSFB,
in order to prepare for the Digex board meeting later that day. During the time
when the Special Committee was meeting with their financial advisors at CSFB's
New York offices, Ebbers of WorldCom had a 45-minute telephone conversation with
Jalkut and Reich, as Clark had requested.(29) Ebbers explained the reasons why
WorldCom had changed the deal. Ebbers also explained that WorldCom intended to
keep Digex public. Grothe spoke to Shull and Adams in a separate call, also
arranged by Clark. Grothe reiterated WorldCom's intention to keep Digex public.
Around 1 p.m. Jalkut and Reich left CSFB's offices to go to Bear Stearns, where
the Intermedia meeting was in progress. Immediately following the Intermedia
meeting, the Digex board met.(30)
F. The Intermedia board meeting
The Intermedia board also met on the morning of September 1 to discuss
the proposed WorldCom transaction. Following their discussion of the need for a
Section 203 waiver by Digex, the Intermedia board meeting was adjourned and
Reich, Jalkut, and Shull, as well as the Special Committee's advisors, were
invited into the room for a meeting of the full
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(28) See Jalkut Dep. at 81-83.
(29) See Sutcliffe Dep. at 259-60.
(30) See Shull Dep. at 171.
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Digex board. The interested directors of Digex, who had been in the room for the
Intermedia meeting, remained, as did Bear Stearns, for the Digex meeting.
G. The Digex board meeting
Sutcliffe informed the Digex board that Intermedia had considered the
WorldCom and Global Crossing proposals and determined that the WorldCom proposal
was better for Intermedia. CSFB presented its findings to the entire board. CSFB
concluded that the WorldCom deal was the worst for Digex.(31) None of the
directors asked any questions regarding CSFB's conclusions.
As had been planned at the breakfast meeting, Jalkut proposed a
mini-auction of Digex, i.e., that a decision on the WorldCom transaction be
deferred for approximately three days to allow CSFB to solicit best and final
offers from WorldCom, Exodus, and Global Crossing, as well as to determine
whether any other potential bidders existed. After some discussion, the proposal
was defeated by a vote of four to three. The three disinterested directors voted
in favor of the auction and the four interested directors voted against any step
that would delay the WorldCom transaction.
The Digex board then turned its attention to the Section 203 waiver.
The debate, however, was brief and truncated, with discussion limited to the
issue of who should vote on the waiver. Clark argued that due to the clear
conflicts of interest faced by the interested directors, they should abstain
from the vote. Sutcliffe asserted that he saw no reason to prevent the
interested directors from participating. Sutcliffe would later testify that, "I
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(31) See Def. Intermedia's Br. at 20-21 and Pls.' Br. at 27.
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discussed with [the interested directors] or reminded them that in voting on
anything as a Digex director, they had to disregard entirely their relationship
with Intermedia and had a fiduciary obligation to act only in the best interest
of Digex and all of its shareholders."(32) The Special Committee was never asked
for a recommendation on this conflict. After some discussion regarding whether
or not the interested directors should vote, it was decided that all board
members should vote. As noted above, it appears from the record that Clark and
Sutcliffe disagreed about whether it was appropriate for the interested Digex
directors to vote on the Section 203 waiver. It is far less clear whether the
Digex directors themselves engaged in any discussions along these lines.(33) The
vote, once again, was four to three, with only the interested directors-Ruberg,
Manning, Campbell, and Baker-voting in favor of the Section 203 waiver. After
the Digex board members voted on the Section 203 waiver, the Intermedia board
reconvened, received Bear Stearns' oral fairness opinion, and approved the
Intermedia merger with WorldCom.
H. Procedural History
Following the public announcement on September 5, 2000, of the proposed
merger between Intermedia and WorldCom, Digex stockholders filed a series of
class and derivative stockholder suits. Ultimately, all of the actions were
consolidated into this single action and WorldCom was joined as a party
defendant. On October 2, 2000, this Court granted plaintiffs' motion for
expedited proceedings. Thereafter, the parties engaged in expedited
--------
(32) Sutcliffe Dep. at 267.
(33) See Decker Dep. at 327; Shull Dep. at 191-92; Sutcliffe Dep.
at 310-11.
16
<PAGE> 20
discovery, including the production of documents, numerous depositions, and the
filing of legal memoranda. Plaintiffs' motion for a preliminary injunction was
argued before the Court on November 29. At the Court's request, the parties
filed supplemental memoranda regarding the Section 203 issue on December 4.
II. STANDARD FOR A PRELIMINARY INJUNCTION
This matter is presently before the Court on plaintiffs' motion for a
preliminary injunction. When seeking a preliminary injunction, a plaintiff must
demonstrate a reasonable probability of success on the merits and that some
irreparable harm will occur in the absence of the injunction. Furthermore, in
evaluating the need for a preliminary injunction, the Court must balance the
plaintiff's need for protection against any harm that can reasonably be expected
to befall the defendants if the injunction is granted. When the former outweighs
the latter, then the injunction should issue.(34)
As I noted earlier, the plaintiffs assert two different legal theories
in this action. First, they argue that the defendants have breached their
fiduciary duties and usurped a corporate opportunity that belonged to Digex and
its shareholders. Second, the plaintiffs contend that the defendants breached
the fiduciary duties they owed to Digex and its shareholders by voting to waive
the protections afforded by Section 203. 1 turn first to the corporate
opportunity theory.
--------
(34) Mills Acquisition Co. v. MacMillan, Inc., Del. Supr., 559 A.2d
1261, 1278-79 (1988). See also Kaiser Aluminum Corp. v.
Matheson, Del. Supr., 681 A.2d 392, 394 (1996).
17
<PAGE> 21
III. THE CORPORATE OPPORTUNITY CLAIM
Delaware Courts employ the following test to determine whether a
corporate opportunity has been usurped by a fiduciary. The corporate opportunity
will be found to have been usurped:
If there is presented to a corporate officer or director a business
opportunity which the corporation is financially able to undertake,
[and that opportunity] is . . . in the line of the corporation's
business and is of practical advantage to it, is one in which the
corporation has an interest or a reasonable expectancy, and, by
embracing the opportunity, the self-interest of the officer or director
will be brought into conflict with that of his corporation . . .(35)
It is with this test in mind that I will evaluate the plaintiffs' claim that the
defendants have usurped a corporate opportunity belonging to Digex.
A. Summary of the Arguments
The plaintiffs argue that they satisfy all elements of the test for the
usurpation of a corporate opportunity and, thus, there is a likelihood that they
will succeed on the merits at trial. The opportunity that plaintiffs insist they
had was an "expectancy" in selling their Digex shares to a buyer for
approximately $120.00 per share.
That expectancy, the plaintiffs urge, was created by Intermedia's
alleged promise that any deal Intermedia brokered would include a sale of the
Digex minority shareholders' shares. As the argument goes, the defendants
breached their fiduciary duties when the Intermedia-affiliated Digex directors
allegedly steered WorldCom away from a Digex deal
--------
(35) Yiannatsis v. Stephanis, Del. Supr., 653 A.2d 275 (1995)
(quoting Guth v. Loft, Inc., De. Supr., 5 A.2d 503 (1939)).
18
<PAGE> 22
and towards an Intermedia deal.(36) When a WorldCom-Intermedia deal originally
arose, plaintiffs argue that the interested directors had several courses of
action available that would have avoided such a breach. For instance, "they
could have refused to discuss with WorldCom anything other than an acquisition
of Digex, or they could have conditioned any acquisition of Intermedia on
WorldCom's agreement to make a tender offer for the minority shares of
Digex.(37) The import of this, urge plaintiffs, is that "when WorldCom asked
Intermedia for a price at which WorldCom could acquire Intermedia, Intermedia
was not permitted to name its price and make an agreement with WorldCom without
informing Digex's Special Committee and affording it an opportunity to negotiate
with WorldCom on behalf of Digex."(38)
The defendants respond to these contentions with three primary
arguments. First, they argue that there was no corporate opportunity to usurp
because "Intermedia owns an absolute majority of Digex's voting rights and
equity. Intermedia is entitled to sell or refuse to sell its Digex stock solely
in its own interest; it is entitled to vote its shares in its own interest; and,
neither the Digex board nor its shareholders can sell Digex without
--------
(36) The precise conduct of the Intermedia-affiliated Digex
directors and WorldCom's representatives is seriously disputed
by the parties. Moreover, it is quite difficult on the record
currently before the Court to believe one party over the other
because the Court has no opportunity to evaluate the
credibility of witnesses. Thus, where the facts are in
dispute, I will acknowledge such during the discussion of
particular issues.
(37) Pls.' Opening Br., p. 33.
(38) Id. at 35.
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<PAGE> 23
Intermedia's consent.(39) The second argument the defendants make is that they
acted properly and mindful of their fiduciary duties at all relevant times.
Thus, because the defendants were entirely candid with the Digex board and
because WorldCom approached Intermedia as the controlling shareholder rather
than Digex itself, there can be no breach of the duty of loyalty. Finally, and
tangentially related to the first argument, defendants contend that the Digex
minority shareholders had no power to insist that Intermedia, as controlling
shareholder, permit Digex to conduct an "auction" to sell itself to the highest
bidder.
B. Legal Analysis
For the reasons discussed below, I conclude that Digex, as a
corporation, had no legally cognizable "interest or expectancy" in a
WorldCom-Digex deal. Thus, the plaintiffs will not be able to prove an element
of the corporate opportunity doctrine and are unlikely to succeed on the merits.
Moreover, while the behavior of certain actors in this corporate drama do not
paint a picture of model director behavior, I cannot conclude, on the limited
factual record before me, that the defendants' conduct was undertaken in bad
faith. Because I am deeply skeptical that the plaintiffs will be able to produce
evidence at trial to prove their currently unsupported suspicions, I am not
persuaded that plaintiffs have a reasonable probability of success on the merits
of their corporate opportunity claim.
--------
(39) Intermedia's Answering Br., p. 26.
20
<PAGE> 24
1. Why Digex had no "interest or expectancy" in a
WorldCom-Digex deal.
A claim that a director or officer improperly usurped a corporate
opportunity belonging to the corporation is a derivative claim.(40) Here, it is
helpful to distinguish between a derivative and an individual claim.
As a general matter, it may be said that, where the substantive nature
of the alleged injury is such that it falls directly on the corporation
as a whole and collectively, but only secondarily, upon its
stockholders as a function of and in proportion to their pro rata
investment in the corporation, the claim is derivative in nature and
may be maintained only on behalf of the corporation. . . . Conversely,
where the complaint describes a special and distinct injury inflicted
directly on rights of individual stockholders traditionally regarded as
an incident of their stock ownership, the action is individual (or
class) in nature, and any ensuing recovery or other relief runs
directly to the stockholders. In other words, derivative actions are
those that seek relief for injuries done to the corporation, while
individual or class claims are those that seek to rectify harm
inflicted directly upon the individual rights of stockholders.(41)
With this distinction in mind, the claim that the defendants usurped a corporate
opportunity must necessarily constitute an "injury" to the corporation and thus
be a derivative claim.(42)
Here, the plaintiffs contend that the defendants, by allegedly steering
WorldCom away from a Digex deal and towards an Intermedia deal, appropriated an
opportunity that
--------
(40) See Cooke v. Oolie, Del. Ch., C.A. No. 11134, Chandler, C.
(June 23, 1997) mem. op. at 33, n.96.
(41) Donald J. Wolfe and Michael A. Pittenger, Corporate and
Commercial Practice in the Delaware Court of Chancery Section
9-2(a), at 517-18 (1998).
(42) No party has argued that the "demand" requirement for a
derivative suit has not been satisfied. I do not reach that
issue, however, because it has not been raised and it appears
likely that demand would have been "futile" given the record
before me.
21
<PAGE> 25
belonged to the plaintiffs. That opportunity was the ability to sell Digex to
the highest bidder.
The opportunity the plaintiffs identify, however, is not an "interest
or expectancy" of Digex the corporation qua corporation. Rather, the purported
opportunity is that of the Digex shareholders to sell their Digex shares to the
highest bidder. Thus, the perceived corporate opportunity is not really a
corporate opportunity at all, but more closely resembles an individual
opportunity of the shareholders. Because the opportunity the plaintiff's
identify was not one in which Digex as a corporation had an "interest or
expectancy," plaintiffs do not have a reasonable likelihood of success on such a
claim.
The present case also is strikingly similar to Thorpe v. CERBCO,
Inc.,(43) a case cited by both parties as supporting their respective positions.
In CERBCO, the Supreme Court held that where a majority shareholder of a
corporation can block any unacceptable transaction, the corporation cannot take
advantage of the opportunity to enter into an unsanctioned transaction and,
thus, there is no opportunity that fairly belongs to the corporation.(44)
George and Robert Erikson were directors, officers, and controlling
shareholders of CERBCO, Inc. While the Eriksons owned 24% of CERBCO's total
equity, they exercised effective voting control with 56% of the total votes.
They were also two of the four directors on CERBCO's Board.
--------
(43) Del. Supr., 676 A.2d 436 (1996).
(44) Id. at 443.
22
<PAGE> 26
CERBCO, as a holding company, owned voting control of a subsidiary,
Insituform East, Inc. ("East"). A third party approached the Eriksons in their
capacity as directors and officers(45) of CERBCO to discuss the possible
purchase of the subsidiary East. The Eriksons, however, steered the third-party
towards buying their controlling interest in the parent CERBCO as a way to gain
control of the subsidiary East. Thorpe, a CERBCO shareholder, filed a derivative
suit claiming that the Eriksons had diverted from CERBCO the opportunity to sell
East to the third-party. Thus, as is quite plain, in many respects the facts of
CERBCO are similar to those here.(46)
The Court of Chancery, following a trial, found that the Eriksons
violated their duty of loyalty to CERBCO. "Despite finding this breach,"
however, "the Chancellor held that the plaintiffs would not be awarded damages
since the defendants actions were wholly fair."(47) The Chancellor found that
the Eriksons could not be penalized for their breach because they could veto any
proposed transaction under 8 Del C. Section 27(48) and, thus, the plaintiff
suffered no damage.
The Supreme Court, in addressing the issue of the corporate
opportunity, found that:
--------
(45) Apparently, the third party was unaware of the Erikson's
voting control over CERBCO. Id. at 438.
(46) CERBCO also contains an extensive discussion of the Erikson's
duties of loyalty to CERBCO. The facts germane to that
discussion will be highlighted in the following section of
this opinion.
(47) Id. at 441.
(48) This section of the DGCL provides the procedure for a sale,
lease, or exchange of all or substantially all of a
corporation's assets.
23
<PAGE> 27
In this case, it is clear that the opportunity was one in which the
corporation had an interest. Despite this fact, CERBCO would never be
able to undertake the opportunity to sell its EAST shares. Every
economically viable CERBCO sale of stock could have been blocked by the
Eriksons under Section 271. Since the corporation was not able to take
advantage of the opportunity, the transaction was not one which,
considering all the relevant facts, fairly belonged to the
corporation.(49)
The Court went on to find that the "Section 271 fights, not the breach [of the
duty of loyalty], were the proximate cause of the nonconsummation of the
transaction. Accordingly, transactional damages are inappropriate."(50)
I understand the Supreme Court's holding in CERBCO to require a finding
that, while majority shareholders may breach their duty of loyalty on similar
facts, the powers inherent in the majority status generally preclude a plaintiff
from claiming that a corporate opportunity has been usurped where the majority
shareholder could have blocked the transaction in any event. This is so because
no "interest or expectation" fairly belonged to the corporation since the
majority could block the transaction at any time.
The same reasoning leads to the same result in this case. Just as the
Eriksons could block CERBCO's efforts to sell the subsidiary East, so Intermedia
may block any undesirable transactions involving its subsidiary Digex.(51) Of
course, CERBCO teaches that
--------
(49) CERBCO, 676 A.2d at 443.
(50) Id. at 444.
(51) I acknowledge the plaintiff's lengthy argument that Intermedia
was in no financial condition to resist any and all deals.
While that may or may not be the case, no matter what the
financial condition of Intermedia, one solution was to do
exactly as it has--sell itself.
24
<PAGE> 28
this power, held by the controlling shareholder, is not without limit. As is
discussed more fully below, the exercise of that power is always constrained by
the duty of loyalty.
In some respects this case is clearer than CERBCO because here the
complaining parties, Digex and its shareholders, are totally removed from the
transaction between WorldCom and Intermedia. No Digex shares will change hands
and, presumably, Digex's preexisting relationship with Intermedia will be the
same. Intermedia would merely have a new owner.
Because the defendants could block proposed transactions involving the
sale of Digex, it seems unlikely that Digex and its shareholders could have a
legally cognizable interest or expectancy in a WorldCom-Digex deal. In the
absence of such a protectible interest, plaintiffs have no reasonable
probability of success on the merits of their corporate opportunity claim.
2. Did defendants breach their duty of loyalty in
negotiating the WorldCom-Intermedia deal?
In the context of the corporate opportunity claim, plaintiffs appear to
rely upon two distinct theories as to how the defendants breached their
fiduciary duties. First, they contend defendants breached the duty of loyalty by
usurping a corporate opportunity, a claim which (as already mentioned) stands
little chance of success. Second, they argue that the recent decision in
McMullin v. Beran(52) requires a finding that the defendants breached their
fiduciary duties by not conducting "a Revlon auction for Digex."
--------
(52) Del. Supr., ____ A.2d ____, No. 611, 1999, Holland, J. (Nov.
20, 2000).
25
<PAGE> 29
As to this second theory, Thorpe v. CERBCO again is instructive. There
the Supreme Court separated the consideration of whether the defendants usurped
a corporate opportunity and whether they breached their duty of loyalty. Since I
have already addressed the corporate opportunity aspect of the argument, I now
turn to the duty of loyalty aspect.
The CERBCO Court found the Eriksons had breached their duty of loyalty
to CERBCO. How the CERBCO Court reached that conclusion will guide this Court in
determining whether the defendants have breached a duty of loyalty owed to the
plaintiffs.
In CERBCO, the third party approached the Eriksons, in their capacity
as officers and directors, about the potential purchase of the subsidiary, East.
The Eriksons, however, immediately steered the third-party towards purchasing
their controlling block of CERBCO in order to gain control of East.(53)
The Eriksons never informed the other CERBCO board members of this
interest in the subsidiary East, but did inform them of the proposed sale of the
Eriksons' stock. In fact, a member of the CERBCO board later specifically asked
the Eriksons whether there had been any interest in a purchase of East. "The
Eriksons denied that [the third-party] had ever made such an offer, and had
[they] done so, the Eriksons indicated that they would likely vote their shares
to reject it."(54)
--------
(53) Thorpe v. CERBCO, Inc., 676 A.2d at 438.
(54) Id. at 439.
26
<PAGE> 30
Ultimately, it was this lack of candor that led both the Chancellor and
the Supreme Court to find that the Eriksons had breached their duty of
loyalty.(55) To reach this result, the Court applied the following analysis:
The shareholder vote provided by Section 271 does not supercede the
duty of loyalty owed by control persons, just as the statutory power to
merge does not allow oppressive conduct in the effectuation of a
merger. Rather, this statutorily conferred power must be exercised
within the constraints of the duty of loyalty. In practice, the
reconciliation of these two precepts of corporate law means that the
duty of a controlling shareholder/director will vary according to the
role being played by that person and the stage of the transaction at
which the power is employed.(56)
In applying this analytical framework, the Court decided that since the
Eriksons were approached in their capacities as directors of CERBCO, their
loyalties should have been to the company. To satisfy their duty to act in good
faith, the Eriksons should have informed the CERBCO board of the interest in
East and CERBCO should have been able to explore that interest "unhindered by
the dominating hand of the Eriksons."(57)
The Court recognized that "[t]he Eriksons were entitled to profit from
their control premium and, to that end, compete with CERBCO but only after
informing CERBCO of the opportunity. Thereafter, they should have removed
themselves from the negotiations and allowed the disinterested directors to act
on behalf of CERBCO."(58) Finally, "[w]hile the
--------
(55) See id. at 441.
(56) Id. at 442 (citations omitted).
(57) Id.
(58) Id. at 442.
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<PAGE> 31
Eriksons did have a duty to present that opportunity to CERBCO, they had no
responsibility to ensure that a transaction was consummated."(59)
Thus, if one compares the Eriksons' behavior to that of the defendants
here, I must consider whether the defendants adequately disclosed any potential
interest or proposal to Digex and provided Digex a reasonable opportunity to
act. If the defendants did not act in that manner, it may well suggest that they
breached a duty of loyalty to Digex's minority shareholders.
To answer this question, one must focus on the events that occurred
between August 30, 2000, and September 1, 2000.(60) Viewing those events
objectively, it appears that Digex, through its officers and non-interested
directors, was apprised of the status of the various proposed transactions at
all times. Despite preliminary posturing and expressions of general interest in
the preceding months, the time frame at issue was compressed into a matter of a
few days. The evidence indicates that WorldCom was interested in Digex and had
--------
(59) Id. at 444.
(60) I note that the parties hotly contest the events on August 31,
2000, that led WorldCom to switch from a purchase of Digex to
a purchase of Intermedia. After substantial discovery, the
plaintiffs can point to little concrete evidence in the record
to refute the defendants' claim that the decision to acquire
Intermedia was solely WorldCom's decision. The plaintiffs
point to much circumstantial evidence that suggests
impropriety, yet after carefully reviewing the deposition
testimony, together with later affidavits which in some
respects contradict the depositions, it nonetheless appears
doubtful to me that the plaintiffs will be able to overcome
the testimony that the decision to switch deals was WorldCom's
alone. For the sake of this discussion, however, I will limit
my references and consideration to those facts that are not
seriously in dispute.
28
<PAGE> 32
considered various ways to gain control of it. Among those options was either a
purchase of Digex itself or of Intermedia to gain control of Digex.
On August 30, WorldCom representatives contacted the bankers that were
assisting Intermedia in exploring its options, two of which were either selling
itself or selling its "crown jewel," Digex. WorldCom was told that a purchase of
Digex would require an offer of upwards of $120.00 per share. WorldCom was not
deterred and began due diligence. WorldCom was aware that it was working to beat
a September 1, 2000, deadline. Digex representatives were immediately notified
of this new interest. Thus, at this point, Digex, through its representatives,
was aware of WorldCom's initial interest in the company.
Sometime on August 31, however, WorldCom decided that a purchase of
Intermedia was more desirable than a purchase of Digex because of the
significant cost savings. WorldCom made a preliminary inquiry into what price
Intermedia would seek, and was told that it could purchase Intermedia for $39.00
per share. As WorldCom found this initial term agreeable, it decided to shift
its due diligence to consider a purchase of Intermedia with consummation of the
deal the following day. Shortly after the change in the deal, the Digex officers
and non-interested directors were informed of the change. Thus, within a very
short time, Digex had notice that it was no longer the focus of a WorldCom deal.
These facts are not in serious dispute. Viewed in light of CERBCO's
analysis, they lead me to conclude, although provisionally, that the defendants
did not breach their duties of loyalty to the plaintiffs at this juncture in the
negotiation process. Digex had notice of WorldCom's interest from the beginning,
although it had been assured by Intermedia's
29
<PAGE> 33
representatives that any negotiated sale of Intermedia's majority interest in
Digex would seek to include an offer for the minority public shareholders.
Moreover, Digex apparently was notified of WorldCom's change of heart within a
short time of the switch. At this point, I do not find persuasive the
plaintiffs' contention that the deal was a fait accompli merely because there
had been a preliminary agreement as to price. Although I recognize that an
effort by Digex to revive a WorldCom-Digex deal may have been futile considering
Intermedia's stance, the defendants only had to give fair notice of the
opportunity to Digex. In these circumstances, I do not think it likely that
plaintiffs can show the Intermedia defendants, as a controlling stockholder, had
a duty to see that a particular transaction involving Digex was consummated.
Nor does the defendants' behavior approach the egregiousness of the
Eriksons. Unlike CERBCO, Digex knew of WorldCom's initial interest from the
beginning. Moreover, defendants made no attempt to conceal the fact that the
deal had changed. As this Court found in another case with analogous facts:
Although we encourage directors to aspire to ideal corporate governance
practices, directors' actions need not achieve perfection to avoid
liability. Directors must adhere to the minimum legal requirements of
the corporation law. Although the defendants failed to act as a model
director might have acted, for the above reasons and on the undisputed
facts I conclude, as a matter of law, they did not breach a legal
duty.(61)
--------
(61) Cooke v. Oolie, Del. Ch., C.A. No. 11134, Chandler, C. (May
24, 2000) mem. op. at 45.
30
<PAGE> 34
Based on my review of the mostly undisputed evidence at this juncture, I
conclude that plaintiffs have not demonstrated a reasonable likelihood of
success on the merits of their breach of the duty of loyalty claims.
3. Are the defendants estopped from completing a
WorldCom-Intermedia deal?
An additional matter I must address is an argument that the plaintiffs
raise in their reply brief-that the defendants should be estopped from agreeing
to a sale of Intermedia.(62) The gist of the argument is that Intermedia
promised Digex and its shareholders that any transaction Intermedia pursued
would necessarily involve the concomitant purchase of the minority interest in
Digex.
This argument takes its genesis from Intermedia's early expressions
that it needed to complete some kind of deal to rectify adverse financial
conditions. To that end, Intermedia issued a press release in July, 2000,
stating that it had "retained Bear Stearns to explore strategic alternatives
with regard to Digex, including the possible sale of Intermedia's ownership
position in Digex to another company.(63) The plaintiffs also point to the board
minutes from a June 29, 2000, board meeting for the proposition that Intermedia
promised that any deal it sought would include Digex's minority shareholders.
The passage they highlight states: "Responsive to a question from one of the
directors, Mr. Sutcliffe indicated
--------
(62) Pls.' Reply Br. states the argument as: "Intermedia's
fiduciary duties, as well as the doctrines of promissory
estoppel and equitable estoppel, prevent Intermedia from
selling its shares in its own interest in this case." Reply
Br. at 19.
(63) Pls.' Ex. 13 (July 11, 2000, Intermedia press release)
(emphasis added).
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<PAGE> 35
that it was Intermedia's present intention to require from any proposed
purchaser of Intermedia's equity interest in Digex an undertaking to make a
comparable offer available to the public stockholders of [Digex]."(64)
The plaintiffs' arguments on this issue, and the supporting evidence
they rely upon, demonstrates their fundamental misunderstanding of Intermedia's
intentions. This misunderstanding, perhaps, explains in part the catalyst for
this litigation. The record evidence, however, does not fairly support such a
broad reading of Intermedia's intentions. Intermedia clearly expressed its
intention that if it sold its majority stake in Digex, it would seek a
comparable deal for the minority shareholders. This is the sum and substance of
the evidence on this point at this preliminary stage of the proceeding, and it
cannot be understood (at least not yet) as promising anything more or anything
less. One certainly cannot read the evidence as legally obligating Intermedia to
secure a transaction for the Digex minority shareholders when Intermedia sells
itself. Moreover, based on the limited available evidence at this juncture, one
could not reasonably conclude that Intermedia made a blanket promise that any
deal it considered would necessarily involve a deal for the Digex minority.
Given the state of the record, plaintiffs' estoppel theory does not appear
reasonably likely to succeed on the merits.
--------
(64) Quote taken from Pls.' Opening Br. at 6 (emphasis added).
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<PAGE> 36
4. Is this a Revlon case?
Although presented awkwardly and belatedly, I will address plaintiffs'
argument that "[t]he individual defendants breached their fiduciary duties under
Revlon."(65) It is a well-known principle of Delaware corporate law that the
decision in Revlon v. MacAndrews & Forbes Holdings, Inc.(66) requires a board to
maximize the value to all shareholders when a sale of control of the business is
inevitable.(67) Plaintiffs insist that a sale of Digex was inevitable and that
an auction was required to be held to that end, in accordance with Revlon. For
several reasons, I also believe this version of the corporate opportunity claim
enjoys little likelihood of succeeding on its merits.
First, plaintiffs' so-called Revlon claim is not properly before the
Court. Several plaintiffs asserted Revlon claims in their original complaints,
but all of these claims were voluntary dropped when the consolidated class and
derivative complaint was filed. Thus, no properly alleged Revlon claim exists
for this Court to consider.
Second, even if such a claim were properly alleged, it would have
little likelihood of success. Revlon and its progeny address the policy concern
that minority shareholders are particularly vulnerable when a proposed
transaction will result in a change of control in their corporation.(68) This
concern by the courts stems from the concept that "[w]hen a majority
--------
(65) Pls.' Reply Br. at 7.
(66) Del. Supr., 506 A.2d 173 (1985).
(67) Id. at 182.
(68) See McMullin v. Beran, Del. Supr., ___ A.2d ___, No. 611,
1999, Holland, J. (Nov. 20, 2000); Paramount Communications,
Inc. v. QVC Network, Inc., Del. Supvr., 637 A.2d 34 (1994);
and Paramount Communications, Inc. v. Time, Inc., Del. Ch.,
C.A. No. 10866, Allen, C. (July 17, 1989), aff'd, Del. Supr.,
571 A.2d 1140 (1990).
33
<PAGE> 37
of a corporation's voting shares are acquired by a single person or entity, or
by a cohesive group acting together, there is significant diminution in the
voting power of those who thereby become minority stockholders."(69)
In this case, however, no "change of control" is proposed regarding
Digex. The Digex minority existed before the proposed merger and it will not
change under the proposed transaction. What will change is the ownership of
Digex's majority shareholder, Intermedia.(70)
Finally, it is important to recognize that any effort to sell Digex in
a Revlon-style auction would appear to be futile.(71) As Vice Chancellor Lamb
observed in Odyssey Partners, L.P. v. Fleming Co., Inc.:(72) "Revlon duties do
not arise where the directors do not
--------
(69) Paramount Communications Inc., 637 A.2d at 42.
(70) It is noteworthy that the Supreme Court's recent decision in
McMullin appears to indicate that even if Intermedia were
selling its approximately 60% equity interest in Digex, rather
than selling itself, that transaction also would not trigger
Revlon. See McMullin, ___ A.2d at ___, No. 611, 1999 at 18-19)
("The Amended Complaint does contend that the Chemical Board's
recommendation to approve the Lyondell Transaction implicated
the directors' ultimate fiduciary duty that was described in
Revlon and its progeny- to focus on whether shareholder value
has been maximized. We agree with that contention because,
rather than selling only its own 80% interest, ARCO negotiated
for, with the Chemical Board's approval, the entire sale of
Chemical to Lyondell." (emphasis added)).
(71) See McMullin at 17. See also Bershad v. Curtis-Wright Corp.,
Del. Supr., 535 A.2d 840, 845 (1987) (noting "futility" of
directors "assum[ing] the role of auctioneers" where majority
stockholder had power to thwart any such efforts).
(72) Del. Ch., 735 A.2d 386, 416 (1999).
34
<PAGE> 38
have the power to control the terms on which a sale of the company takes place."
Where, as here, a majority shareholder can block proposed transactions involving
a sale of control, the courts will not require a board of directors to engage in
a futile exercise, even though the board continues to own requisite fiduciary
duties to its shareholders.(73) This claim thus has little chance of ultimate
success.
To summarize, it does not appear that the plaintiffs' direct and
related claims-that the defendants usurped a corporate opportunity allegedly
belonging to Digex-have a reasonable probability of success on the merits.
First, Digex had no "interest or expectancy" in a WorldCom-Digex transaction
that fairly belonged to it. Second, the evidence suggests that Digex was
informed of WorldCom's initial interest in evaluating a purchase of Digex. It
does not appear that that matter was concealed from Digex by the defendants. In
addition, Digex, through its representatives, was notified that WorldCom's
interest had switched to purchasing Intermedia. Third, it does not appear that
the evidence would support a conclusion that the defendants made an enforceable
"promise" that in any event the Digex minority shareholders' interests would be
purchased. Nor does the record indicate that the Intermedia defendants made
unequivocal statements that all of Digex would be sold. Finally, Digex had no
power to compel its majority stockholder, Intermedia, to sell Digex in a
Revlon-style auction.
--------
(73) See McMullin at 17 ("Under the circumstances presented in this
case, although the Chemical Board could not effectively seek
an alternative to the proposed Lyondell sale by auction or
agreement, and had no fiduciary responsibility to engage in
either futile exercise, its ultimate statutory duties under
Section 251 and attendant fiduciary obligations remained
inviolable.") (emphasis added).
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Accordingly, I am not persuaded that plaintiffs have demonstrated a
reasonable likelihood of success on the merits of the various claims they have
made under the rubric of the corporate opportunity theory.
IV. SECTION 203 CLAIM
In their second claim, the plaintiffs argue that the interested Digex
directors breached their fiduciary duties by causing Digex to improperly waive
Section 203 of the DGCL. Specifically, the plaintiffs assert that because the
waiver was accomplished by the vote of the four Intermedia-affiliated Digex
directors, and against the vote and advice of the three independent Digex
directors, the vote must be judged under the entire fairness standard.
Plaintiffs contend that the defendants have failed to meet this standard.
I first turn to the operative statute. The applicable provisions of
Section 203 read as follows.
(a) Notwithstanding any other provisions of this chapter, a
corporation shall not engage in any business combination with
any interested stockholder for a period of 3 years following
the time that such stockholder became an interested
stockholder, unless:
(1) prior to such time the board of directors of the
corporation approved either the business combination
or the transaction which resulted in the stockholder
becoming an interested stockholder, or
(2) upon consummation of the transaction which resulted
in the stockholder becoming an interested
stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced,
excluding for purposes of determining the number of
shares outstanding those shares owned (i) by persons
who are directors and also officers and (ii) employee
stock plans in which employee participants do not
have the
36
<PAGE> 40
right to determine confidentially whether shares held
subject to the plan will be tendered in a tender or
exchange offer.(74)
As is clear on its face, once an entity becomes an "interested
stockholder," Section 203, subject to certain exemptions, prohibits business
combinations between a Delaware corporation and that shareholder for a period of
three years.(75) There is no dispute between the parties that WorldCom will
become an interested shareholder in Digex as a result of the merger and that
WorldCom intends to enter into transactions with Digex where the prohibitions of
Section 203 would apply absent an exemption. As a result, although WorldCom
believes that it would come within the statutory exemption provided by Section
203(a)(2) for interested stockholders holding 85% or more of the "voting stock"
of the corporation, WorldCom also sought the additional certainty that would
come with a Section 203(a)(1) waiver agreed to by the Digex board of directors.
WorldCom was not content to rely merely on the 85% shareholder exemption because
it recognized that the application of the Section 203(a)(2) exemption in
situations involving "super-voting rights" has not been definitively ruled upon
by the Delaware courts. There is also no dispute that the Digex board voted to
waive the protections afforded by Section 203. Instead, the plaintiffs contend
that the vote to waive Section 203 amounted to a breach of fiduciary duty.
The defendants make three arguments that the Section 203 waiver did not
constitute a breach of fiduciary duty and therefore will not support preliminary
injunctive relief. First,
--------
(74) 8 Del. C. Section 203(a).
(75) See generally 1 R. Franklin Balotti & Jesse A. Finkelstein,
The Delaware Law of Corporations and Business Organizations,
3rd ed. Sections 6.13-6.34 (1998).
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<PAGE> 41
defendants contend that Section 203 will not prohibit a future business
combination between Digex and WorldCom because even if the waiver was invalid,
WorldCom still is exempt from Section 203 because it will possess over 85% of
the Digex voting power. Second, the defendants assert that the plaintiffs are
asking for an advisory opinion because no business combination has yet been
presented to Digex and, therefore, this dispute is not ripe for adjudication.
Third, the defendants argue that the Section 203 waiver was, in any case,
entirely fair to the Digex shareholders.
A. Does the 85% exemption apply to WorldCom?
The facts are undisputed by either party that upon the completion of
the merger, WorldCom will possess well over 85% of the voting power of Digex but
well under 85% of the number of outstanding voting shares of Digex.(76) The
three year waiting period imposed by Section 203, the Delaware anti-takeover
statute, does not apply where "upon consummation of the transaction which
resulted in the stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the corporation
outstanding at the time that the transaction commenced" excluding certain shares
for the purposes of determining the number of shares outstanding.(77) The
interpretation of the term "voting stock," therefore, lays directly at the
center of this dispute
--------
(76) Defendants state that WorldCom will own a 94.2% voting
interest in Digex. Def. Intermedia's Br. at 35. The economic
interest is 52%.
(77) 8 Del. C. Section 203(a)(2) (emphasis added).
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<PAGE> 42
whether Section 203 limitations would apply to WorldCom absent the waiver.(78)
Simply put, if "85% of the voting stock" refers to voting power, WorldCom would
be exempt from Section 203. If "85% of the voting stock" refers to the number of
shares held in the corporation as a percentage of its outstanding number of
shares, then WorldCom would need to rely on the vote of the Digex board to waive
its Section 203 protections.
The primary support for the defendants' reading of the term "voting
stock" is found in Section 212(a) of the DGCL. Section 212(a) states in relevant
part:
If the certificate of incorporation provides for more or less than 1
vote for any share, on any matter, every reference in this chapter to a
majority or other proportion of stock shall refer to such majority or
other proportion of the votes of such stock.(79)
Based on Section 212(a), the defendants assert that ownership of
"voting stock" under Section 203 must be measured by the voting rights
of that stock rather than the number of shares of that stock entitled
to vote, where, as here, the certificate of incorporation provides for
a class of stock with super-voting rights.(80)
--------
(78) The Court also notes that Section 203(a)(2) is not the only
section of that statute to rely on the definition of "voting
stock." The other provisions of Section 203 that contain this
term include the definition of interested shareholder and the
Section 203(a)(3) exception involving approval for a business
combination by a two-thirds vote of the minority shareholders.
The exemption provided by Section 203(b)(4) also relies on the
concept of "voting stock." Under that exception, a corporation
will not be subject to Section 203 even if shares of
non-voting stock or voting debt instruments may be outstanding
and may satisfy one or more of the Section 203(b)(4)-criteria.
(79) 8 Del. C Section 212(a).
(80) As stated above, the Digex Certificate of Incorporation
provides for a Class B stock with super-voting rights, ten
votes per share.
39
<PAGE> 43
There are problems, however, with this admittedly straightforward
reasoning. First, Section 203 includes a definition of the term in question,
"voting stock." Where a statute specifically defines an operative term in a
definitional section, a court will be bound by that definition and shall not
resort to another statute to interpret that term.(81) Second, the interpretation
presented by defendants is not at all clear upon analyzing the language and
context in which the term "voting stock" is used in Section 203(a)(2). Section
203(c) defines "voting stock" and limits that definition strictly to use of that
term within Section 203 in stating:
As used in this section only, the term: . . . (8) "Voting stock" means,
with respect to any corporation, stock of any class or series entitled
to vote generally in the election of directors and, with respect to any
entity that is not a corporation, any equity interest entitled to vote
generally in the election of the governing body of such entity.(82)
Under this definition, for purposes of determining whether a
shareholder has acquired the 85% figure of Section 203(a)(2), the Legislature
effectively excluded any need for an interested shareholder to acquire
outstanding non-voting shares or shares of stock that have a limited right to
vote for the election of directors.(83) Similarly, voting debt instruments are
not
--------
(81) Stiftel v. Malarkey, Del. Supr., 384 A.2d 9, 21 (1977).
(82) 8 Del. C. Section 203(c)(8). This definition was amended
effective July 1, 1995. At the time of the original adoption
of Section 203 on February 2, 1988, the definition read as
follows: "'voting stock' means stock of any class or series
entitled to vote generally in the election of directors."
(83) See Craig B. Smith & Clark W. Furlow, Guide to the Takeover
Law of Delaware Section II.C, at 28 (1988) (hereinafter "Smith
& Furlow").
40
<PAGE> 44
included in the 85% calculation.(84) The Legislature did not signify that
"voting shares" referred to the voting interest, not the equity interest, held
by those shares.
The language of Section 203(a)(2) itself can be interpreted to attest
to the equity interest, not the voting power, interpretation of "voting shares."
The statute explicitly states that as part of the 85% of voting stock
calculation, one must determine "the number of shares outstanding" (emphasis
added) excluding certain specified shares.(85) This is significant. The statute
does not contemplate the number of votes outstanding. In calculating whether an
interested stockholder has reached the 85% threshold, Section 203(a)(2) directs
the Court to divide a number representing the interest held by the interested
shareholder by the number of shares outstanding. The number representing the
interest of the interested shareholder must therefore also be expressed in terms
of the number of shares, not votes, controlled if this calculation is to make
any sense. If, instead, the statute intended for us to divide the number of
votes held in shares owned by the interested shareholder by the outstanding
number of votes (that is, to calculate the "voting power" of the interested
shareholder), the statute would properly direct us to exclude certain shares for
the purposes of calculating the outstanding number of votes. The statute
therefore seems to place the emphasis in the term "voting stock" on the term
"stock" and not the term "voting."
--------
(84) See Smith & Furlow, Section IV.G, at 78-79.
(85) 8 Del. C. Section 203(a)(2).
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<PAGE> 45
Generally, where a statute is unambiguous, there is no reasonable doubt
as to the meaning of the words used and the Court's role is then limited to an
application of the literal meaning of the words.(86) Where, however, a statute
is ambiguous and its meaning is not clear, the Court must rely upon its methods
of statutory interpretation and construction to arrive at a meaning.(87) If a
statute is reasonably susceptible to different conclusions or interpretations,
it is ambiguous.(88) The fundamental rule in interpreting an ambiguous statute
is to ascertain and give effect to the intent of the Legislature.(89)
The legislative history of Section 203(a)(2), although ultimately
unclear, strongly suggests that those contemplating the adoption of the statute
believed they were talking about an economic equity percentage, not a voting
power percentage. Section 203 received an unprecedented amount of scrutiny
before its adoption.(90) Beginning on November 19, 1987, the initial discussion
draft of the proposed Section 203 was distributed throughout the country and
widely circulated among attorneys, academics, corporations, pension funds,
federal officials, and others interested in developments in Delaware corporate
law.(91) In all, more than 150
--------
(86) See Delaware Solid Waste Authority v. The News-Journal Co.,
Del. Supvr., 480 A.2d 628 (1984).
(87) Coastal Barge Corp. v. Coastal Zone Industrial Control Bd.,
Del. Supr., 492 A.2d 1242, 1246 (1985).
(88) Id.
(89) Id.
(90) For a concise history of the debate in Delaware leading up to
the adoption of Section 203, see Smith & Furlow, Section I.C,
at 8-10.
(91) Smith & Furlow, Section I.C, at 9 n.23.
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<PAGE> 46
comment letters were received from sources as varied as members of the
Securities and Exchange Commission ("SEC"), the Federal Trade Commission,
corporate law academic departments, corporate law practitioners, stockholders,
as well as other individuals with vested interests in takeover activity.(92) In
a further attempt to broaden the scrutiny of Section 203, the Delaware Bar
Association opened its deliberations to the public and sought public comment.
These discussions surrounding Section 203 received wide national press
coverage.(93) Upon signing the bill putting Section 203 into law, then-Governor
Michael Castle stated that Section 203 was "the product of the most intense
debate that I can remember in 20 years in government."(94)
--------
(92) Smith & Furlow, Section I.C, at 9. For examples of these
comment letters, see Smith & Furlow, Appendices C-N, at
155-232.
(93) See, e.g., Francine Schwadel, Delaware Fails to Adopt a Law on
Takeovers, Wall St. J., June 16, 1987, at 2; Paul M. Barrett,
Delaware Moves Closer to Adopting Law to Deter Hostile
Takeovers, Wall St. J., Dec. 9, 1987, at 41; Robert Samuelson,
Corporate Socialism, Newsweek, Dec. 28, 1987, at 42;
Washington Crosses Delaware, Wall St. J., Dec. 31, 1987, at 6;
Elliott D. Lee & Paul M. Barrett, Anti-Takeover Bill Passes in
Delaware, Wall St. J., Jan. 29, 1988, at 9.
(94) Statement By Governor Michael Castle Regarding House
Substitute Bill 396, Signed February 2, 1988, reprinted in
Smith & Furlow, Appendix CC, at 339.
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<PAGE> 47
There are several sources to consider in attempting to appraise the
true legislative intent and purpose behind Section 203.(95) The Legislature
itself included a basic summary of the intent of Section 203 in the Synopsis to
House Bill 396, which was eventually adopted as Section 203:
Section 203 is intended to strike a balance between the benefits of an
unfettered market for corporate shares and the well documented and
judicially recognized need to limit abusive takeover tactics.(96)
Among the comments and submissions considered by the Legislature before
the adoption of Section 203, two members of the Council of the Corporation Law
Section of the Delaware Bar Association submitted a report to the Delaware
General Assembly concerning the proposed Section 203. The report lists six
principal advantages of the statute. Among these advantages, the authors noted
that:
--------
(95) In assessing the purpose of the entire statute after reviewing
the record leading to its adoption, the District Court of
Delaware noted:
The statute offers protection to independent shareholders by
preventing certain dealings between a successful offeror and
the target corporation. In so doing, the statute eliminates
most unsanctioned (by the target's board with or without the
shareholders) freeze-outs, or post-tender offer mergers
between the offeror and the company whereby remaining
shareholders are forced to sell their stock for cash or
securities. Preventing unapproved mergers also effectively
eliminates many leveraged buyouts, in which the assets of the
target company provide resources for servicing the debt
incurred by the bidder in taking control.
BNS Inc. V. Koppers Co., 683 F. Supp. 458, 469 (D. Del. 1988)
(preliminarily upholding the constitutionality of Section 203).
(96) Synopsis to H.B. No. 396. Several such abusive takeover
tactics were discussed in CTS Corp. v. Dynamics Corp. of
America, 481 U.S. 69 (1987) (upholding the Indiana control
share acquisition statute, a precursor to Delaware's adoption
of its anti-takeover statute, Section 203) and Unocal v. Mesa
Petroleum Co., Del. Supr., 493 A.2d 946, 956 (1985).
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<PAGE> 48
The statute creates a balance between offeror on one hand and
shareholder body on the other. The offeror has the seven outs. The
shareholders can insist upon a price which is sufficiently good to take
out 85% of their number. The stockholders are given bargaining strength
through their board of directors who will negotiate for them in a
takeover situation. The only way that stockholders can act effectively
as a group to negotiate with an offeror is through their board of
directors elected by them. They cannot take effective action
independently or even as a group.(97)
This language strongly suggests that the members of the Corporation Law Section
of the Delaware State Bar Association interpreted "85% of the voting stock" to
refer to the number of shares, not votes, owned by an interested shareholder.
This language also emphasizes the crucial role directors must play in protecting
the interests of shareholders during a possible change of control.
The intense debate over Section 203 in part centered on Section
203(a)(2). Specifically, the 85% shareholder exemption was one of the most
disputed provisions in the entire statute and received a tremendous amount of
scrutiny. Among the most vociferous opponents of the 85% shareholder exemption
(originally set at 90%) was then-SEC Commissioner Joseph Grundfest. In a series
of letters and testimony before the Delaware Legislature, Commissioner Grundfest
objected to the 85% exemption because of the unreasonably onerous burden he
believed this requirement would place on tender offers.(98) According to
(97) Michael D. Goldman & Edward M. McNally, "The Delaware Takeover Statute:
A Report to the Delaware General Assembly, "Section 4(b)(1988)
(emphasis added).
(98) See Letter from Joseph Grundfest, Commissioner of the SEC, to David
Brown, Secretary of the Council of the Corporation Law Section of the
Delaware State Bar Association (Dec. 10, 1987), reprinted in Smith &
Furlow, App. E, at 161-77; Letter from Joseph Grundfest, to David Brown
(Dec. 18, 1987), reprinted in Smith &
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<PAGE> 49
Grundfest, after an investigation by the SEC's Office of the Chief Economist, he
was "aware of no case in which a tender offer obtained more than 90% of the
target's shares despite management opposition."(99) In a subsequent letter,
Grundfest argued to lower the then 90% threshold based on a table consisting of
data showing "the number of shares tendered as a percentage of the shares not
already owned by the bidder."(100) On the other side in this debate, Martin
Lipton of the firm Wachtell, Lipton, Rosen & Katz, argued that even the 90%
exemption level would create a "barn-door size exception" to Section 203 and
that it would "be a rare situation where a tender offer will not attract 85% of
the target's non-management
Furlow, App. F, at 179-189; Letter from Joseph Grundfest to David Brown
(Dec. 22, 1987), reprinted in Smith & Furlow, App. G, at 191-93; Letter
from Joseph Grundfest to E. Norman Veasey (Dec. 31, 1987), reprinted in
Smith & Furlow, App. H, at 195-99; Statement of Joseph A. Grundfest
before the House Judiciary Committee of the Delaware State Legislature
of January 20, 1998, reprinted in Smith & Furlow, App. V, at 277-86.
(99) Letter from Joseph Grundfest to David Brown (Dec. 10, 1987), reprinted
in Smith & Furlow, App. F, at 184-85.
(100) Letter from Joseph Grundfest to David Brown (Dec. 18, 1987), reprinted
in Smith & Furlow, App. F, at 184-85.
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<PAGE> 50
stock."(101) Apparently in response to the concerns expressed by
Grundfest and others, the recommended bill ultimately lowered the percentage
exemption from 90% to 85%.(102)
Goldman and McNally's report to the Delaware General Assembly directly
took on the issue of the proper percentage exemption:
Question: Should the one transaction acquisition percentage be lowered
from 85% to 80%?
Answer: No. The statute is designed to defend against the inadequate
offer for all stock. If an offer is a good one, it should obtain 85% of
the stock of the company. This is particularly so where the proposed
statute eliminates from the 85% figure stock owned by director-officers
and by employee stock plans. The Corporate Law Council and section of
the Bar Association believe that 80% is too easy to attain. Moreover,
other states having this type of law have no percentage out.
The votes required by Section 203 have been carefully calculated to
provide the least intrusive measure possible that will still allow the
statute to limit the abusive takeover tactics to which it is directed.
Thus, Section 203 permits an acquiror to go forward with a business
combination within three years if he acquires 85% of the stock because
that should require hi to make his best offer as the way to maximize
his chances of success. Anything less than his best offer will
jeopardize that success.
The 85% threshold is set at that level because there is evidence that
less-than-full-price, coercive tender offers are frequently able to
obtain stock tenders of
_________________________
(101) Statement of Joseph A. Grundfest before the House Judiciary Committee
of the Delaware State Legislature of January 20, 1998, reprinted in
Smith & Furlow, App. V, at 282-83 (quoting memorandum dated November
23, 1987 from Marlin Lipton of Wachtell, Lipton, Rosen & Katz to
clients); See also BNS v. Koppers, 683 F. Supp. at 471.
(102) BNRS v. Koppers. 683 F. Supp. at 471.
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<PAGE> 51
80% or better. Thus, unless Section 203 set a greater than 80%
threshold requirement, it would not preclude the very evil it seek to
prevent.
. . . [As an example of how the statute shall work,] if insiders hold
no stock, the acquiror must obtain 85% of the stock outstanding, but if
insiders held 10% of the stock, then the acquiror must obtain only
75.5% of the total stock outstanding (i.e., 85% of the 90% not held by
insiders).(103)
The comments and interpretations of those involved in the
public debate of Section 203(a)(2)'s 85% exemption imply that these
individuals believed that the 85% figure referred to the percentage of
equity that agreed to tender, not of the voting power held by those
shares. After an extensive search, the Court has been unable to find
any reference to the concept of "voting power" in any of the numerous
comments and statements that were put forward during the debate.
Rather, both sides only argued on what should be the appropriate
percentage of post-tender ownership required to exempt an interested
shareholder from the Section 203 prohibitions.
As this debate over the 85% threshold exception evidences,
Section 203(a)(2) was crafted with the procedures of tender offers in
mind. The primary policy motivation behind this statute was to deter
potential acquirers from using two-tiered highly leveraged tender
offers.(104) The main argument in support of any percentage exemption
was that if an offer successfully attracted such a significant
percentage of the voting shareholders of a
_________________________
(103) Goldman & McNally,Section Questions and Answers (1988) (citations
omitted) (emphasis added).
(104) See Goldman & McNally, Exec. Summ. Section 2.
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<PAGE> 52
corporation, then the tender offer must be a good one.(105) In
conducting a tender offer, the number of votes a given share possesses
at the time of the decision to tender does not figure into the
percentage of shares that have decided to tender although the number of
votes may determine an acquirer's ability to elect directors and direct
corporate policy.(106) The primary policy reason to provide the 85%
exemption was to allow tender offerors an exemption from Section 203 if
their offer was sufficiently attractive to such a high percentage of the
outstanding shares of the corporation. The situation presented here
defeats that intent.
(105) See Goldman & McNally, Exec. Summ. Section 4(b).
(106) The Court notes that Section 203 in no way forecloses all possible
avenues for an interested shareholder with a large amount of voting
power to assert its will over a corporation. Goldman and McNally name
six paths that remain open, including a proxy contest to elect
directors of that shareholder's own choosing, They noted that Section
203:
(a) Does not interfere with any right of an interested
stockholder to make a tender offer directly to the
stockholders.
(b) Does not interfere with market purchases of
additional share by an interested stockholder.
(c) Does not prevent an interested stockholder from
electing its own board of directors.
(d) Does not interfere with a proxy contest by an
interested stockholder to elect a board of directors.
(e) Does not prevent an interested stockholder who has
attained control of a target from carrying on the
company's business in an ordinary manner or from
entering into merger or other business combination so
long as it is with unrelated parties.
(f) Finally, it does not prevent an interested
stockholder from entering into a business combination
if he obtains the consent of two thirds of the
disinterested owners of voting stock.
Goldman & McNally, Exec. Summ. Section 3 (quoted in 1 Balotti & Finkelstein,
at Section 6.16).
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<PAGE> 53
To demonstrate this point, let us assume that a certain
hypothetical shareholder acquires 40% of the equity of a firm through a
tender offer aimed specifically at certain super-voting shares of that
company. Through these super-voting shares, this equity stake
translates into voting power of 90%. Thereby, that shareholder has in
no way made an offer that is attractive to a majority of the firm's
outstanding equity, but defendants would have this Court believe that
this shareholder has satisfied the exemption. This is exactly the type
of behavior the statute is meant to apply to and prevent.
Now, push this hypothetical closer to the facts at hand. Let
us instead assume that a hostile takeover bid is able to entice 52% of
the outstanding shares of a company to accept an initial tender offer.
Further, assume that that 52% equity stake represents 94% of the voting
power of the target corporation. Would the hostile acquirer be exempt
under Section 203(a)(2) and therefore able to effect a second step
squeeze-out using whatever financing the acquirer chooses? The Court
suspects that the answer to that question would be a resounding no.
Similarly, WorldCom's desire to circumvent the prohibitions of Section
203 with its 94% voting power while its equity interest in Digex is
well below the 85% threshold most likely contradicts the policy
concerns that animated the statute.
Defendants counter this policy argument with one of their own.
Essentially, the defendants argue that this could not possibly be the
proper policy intention behind the 85% exemption because, following
that same logic, an "interested shareholder" would only reach the 15%
threshold if that shareholder owns 15% of the outstanding economic
equity of a
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<PAGE> 54
corporation and not merely 15% of the outstanding voting power of the
corporation. The defendants assert that this would have major
implications for shareholders everywhere and it is not at all what the
Legislature intended. Using the example of a hypothetical shareholder
who owns 10% of the equity of a corporation yet controls 51% of its
voting power, the defendants argue that, to be consistent, that
shareholder could not be considered an interested shareholder subject to
Section 203 even though she could enter into transactions and determine
corporate policy. The defendants posit that interpreting "voting shares"
in terms of equity, and not voting, would therefore render the statute
powerless towards this hypothetical shareholder. But I think the
defendants choose to ignore the implications of their hypothetical to
the present case-where this difference between the equity interest and
the voting interest of WorldCom in Digex similarly presents the
potential for abuse. Defendants assert that their hypothetical
shareholder would circumvent, and effectively "gut," the statute. In a
very practical sense, the position taken by the defendants in this case
may have already accomplished that task.
For present purposes though, let us continue to assume that
the legislative record and policy motivations on the issue of the 85%
exemption actually provide no definitive answers in instances involving
super-voting stock. The Court notes, however, that although the
legislative record arguably may not speak directly to the subtleties of
the "voting stock" issue, the possibilities presented by super-voting
stock were clearly within the purview of the debate surrounding the
drafting and adoption of Section 203. Before the adoption of Section
203,
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<PAGE> 55
a number of Delaware corporations had begun to experiment with defensive
techniques based on "scaled voting" in which voting power decreases in
proportion to increased equity ownership(107) and "tenure voting" which keys
voting power to the duration of ownership.(108)
Moreover, super-voting, rights are certainly not a new invention under
Delaware law and were well known and understood by those drafting and commenting
on Section 203 before its adoption. The DGCL has long recognized that, with
respect to corporations authorized to issue stock, voting rights of that stock
may be varied by the certificate of incorporation as between classes and as
between series within a class. Thus, the right to vote certain shares may be
denied entirely, may be limited to certain matters, more or less than one vote
may be given to the shares of any class or series, and the separate vote of a
class or series may be required as a prerequisite to specified corporate
actions.(109) All of these voting right possibilities existed at the time of the
adoption of Section 203. Nevertheless, it appears that the Legislature left open
many potential questions regarding the application of Section 203. In the words
of one set of commentators soon after the enactment of the statute, "[w]hile
Section 203 should not directly affect such voting arrangements, certain aspects
of those arrangements
----------
(107) See, e.g., Providence & Worcester v. Baker, Del. Supr., 378 A.2d 121
(1977).
(108) See, e.g., Williams v. Geier, Del. Supr., 671 A.2d 1368 (1996) (holders
of common stock on record date would receive ten votes per share, and
upon sale or other transfer, each share would revert to one vote per
share status until that share was held by its owner for three years).
(109) 8 Del. C. Sections 102(a)(4), 102(b)(1), 102(b)(4), 151(a), 212(a);
see also 1 Balotti & Finkelstein, at Section 5.6.
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<PAGE> 56
may present interesting interpretive challenges under Section 203. . . . Does
Section 212(a) apply to Section 203?" (110) The authors, like the Delaware
Legislature, apparently left that unanswered question for the Delaware courts to
decide.
Irrespective of the final answer to the question of what is the proper
interpretation of "85% of the voting shares" in Section 203(a)(2), there is no
dispute that this is a close question of Delaware law where strong arguments
have been put forward by both sides. In particular, the strength of the Section
212(a) related definition seems to be belied by the policy rationales and the
legislative intent behind the statute. Moreover, the language of the statute
itself simply offers no definitive answers.
Further, as will be discussed in more depth in Part IV, B, immediately
below, the Court has not been convinced that this defense is legally ripe.
Rather, a decision on WorldCom's qualification for the 85% shareholder exemption
would be purely advisory at this point in time.
Given the difficulty and complexity of this legal issue, there is no
question that the Section 203 waiver had redundant value to WorldCom. WorldCom,
as well as Intermedia and Digex, were all advised by able legal counsel
regarding the applicability of Section 203 and these attorneys disagreed on the
proper interpretation. Perhaps more importantly, based on this disagreement, as
well as the recognition of each lawyer in this matter who advised any of the
parties on the applicability of Section 203, there was no way to definitively
know at the time
--------
(110) Smith & Furlow, at 102.
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of the waiver vote whether WorldCom actually would qualify for the 85%
exception. This alone is enough for this Court to conclude that the waiver had
value and granted some degree of bargaining leverage to Digex. The directors of
the Digex board, regardless of the ultimate applicability of Section 203 to
WorldCom after the completion of this merger, had a fiduciary obligation that
fully applied to them during the vote to grant WorldCom a waiver of the
prohibitions contained in Section 203.
B. Is This Claim Ripe for Adjudication?
The defendants next argue that until WorldCom actually proposes a
"business combination" within three years after the closing of the merger, there
will be no threatened injury and no claim to analyze. This argument
mischaracterizes the plaintiff's claim. In reference to the discussion
immediately above, the defendants make a strong case that, in fact, their
initial defense regarding the applicability of Section 203 is not ripe for
analysis at this point in time. That is, even if the Court could come to a
conclusion regarding WorldCom's qualification for the 85% exemption, a decision
on that argument presented by the defendants would be purely advisory. The
plaintiffs do not challenge any conduct by WorldCom that is governed by Section
203 though. Rather, the plaintiffs have asserted a fiduciary duty claim, not a
statutory claim, against the interested directors of Digex. For the reasons
stated below, I find that this claim is ripe and not hypothetical.
In determining whether a given claim is indeed ripe,
a practical evaluation of the legitimate interest of the plaintiff in a
prompt resolution of the question presented and the hardship that
further delay may
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threaten is a major concern. Other necessary considerations include the
prospect of future factual development that might affect the
determination to be made; the need to conserve scarce resources; and a
due respect for identifiable policies of the law touching upon the
subject matter of the dispute.(111)
Here, the plaintiffs' claim concerns the vote to waive the protections offered
by Section 203, a vote that has already occurred. All the facts relevant to this
vote occurred in the past and left the full factual record in its wake.
Regardless of how Section 203 will apply to WorldCom in the future,
there is no dispute that the waiver was a negotiated term, referenced in the
merger agreement itself, and had value to all parties concerned in the
transaction. A resolution of this matter is of the utmost importance to all of
the parties as the merger moves toward receiving the approval of Intermedia's
shareholders and the closing presumably soon thereafter. The Court also notes
that corporate fiduciaries must be given clear notice of what conduct is and is
not allowed.(112) This claim is clearly ripe and not simply hypothetical.
C. Was the Section 203 Waiver Entirely Fair to the Digex Shareholders?
On its face, Section 203 does not bar interested directors from
participating in a vote to approve a transaction in which an entity becomes an
interested stockholder.(113) Nevertheless, directors must at all times abide by
their fiduciary duties owed to the shareholders of the
--------------
(111) Schick, Inc. v. Amalgamated Clothing and Textile Workers Union, Del.
Ch., 553 A.2d 1235, 1239 (1987) (footnote omitted).
(112) Siegman v. Tri-Star Pictures, Del. Ch., C.A. No. 9477, Jacobs, V.C. (May
30, 1989).
(113) 8 Del. C. Section 203(a)(1). See Smith & Furlow, at 36, n.6
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<PAGE> 59
corporation.(114) When the directors of a Delaware corporation appear on both
sides of a transaction, the presumption in favor of the business judgment rule
is rebutted and the directors are required to demonstrate their "utmost good
faith and the most scrupulous inherent fairness of the bargain."(115)
Where a director holds dual directorships in the parent-subsidiary
context, there is no dilution of this obligation to demonstrate the entire
fairness of specific board actions.(116)
Thus,
. . . individuals who act in a dual capacity as director of two
corporations, one of whom is parent and the other subsidiary, owe the
same duty of good management to both corporations, and in the absence
of a independent negotiating structure, or the directors' total
abstention from any participation in the matter, this duty is to be
exercised in light of what is best for both companies.(117)
Here, the Section 203 waiver decision must be analyzed under the rubric
of entire fairness as all four votes to waive the protections were made by
directors who not only sat on both the boards of Intermedia and Digex, but also
possessed substantial direct, personal financial
--------
(114) See Guth v. Loft, Inc., Del. Supr., 5 A.2d 503 (1939).
(115) Weinberger v. UOP, Iinc., Del. Supr., 457 A.2d 701, 710 (1983).
(116) Id. (citing Levien v. Sinclair Oil Corp., Del. Ch., 261 A.2d 911 (1969)).
(117) Id. at 710-11 (citing Warshaw v. Calhoun, Del. Supr., 221 A.2d 487, 492
(1966) (citation omitted)).
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interests in the proposed transaction.(118) The waiver by the Digex board
therefore demands careful scrutiny, as the defendants bear the burden of
establishing entire fairness.(119)
As often summarized in our caselaw, the concept of entire fairness has
two basic components, fair dealing and fair price.(120) Fair dealing concerns
how the board action was initiated, structured, negotiated, and timed. Fair
dealing asks whether all of the directors were kept fully informed not only at
the moment in time of the vote, but also during the relevant events leading up
to the vote while negotiations were presumably occurring. Fair dealing also asks
how, and for what reasons, the approvals of the various directors themselves
were obtained.(121) Fair price relates to the economic and financial
considerations of the proposed decision, including any relevant factors that
affect the intrinsic or inherent value of a company's stock.(122) The entire
fairness test is not simply a bifurcated analysis of these two components, fair
dealing and fair price.(123) The Court shall examine these two aspects as well
as any other relevant considerations in analyzing the entire fairness of the
waiver as a whole.
1. Fair Dealing
--------
(118) See supra at n.4.
(119) Weinberger, 457 A.2d at 710.
(120) Id. at 711.
(121) Id.
(122) Id.
(123) Id.
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In attempting to satisfy their burden, the defendants point to several
factors to illustrate that the process leading up to the Section 203 waiver vote
was characterized by fair dealing. The defendants contend that there was
complete candor between the interested directors and the independent Digex
directors. The defendants point out that the Special Committee, along with its
own lawyers and bankers, had participated in the Exodus and Global Crossing
negotiations, had been immediately briefed on all developments in the
Intermedia-WorldCom negotiations, and had been given access to WorldCom prior to
the Digex board meeting through phone calls with Ebbers and Grothe. The
defendants additionally claim that every member of the Digex board, including
the independent directors, "had all the information in Intermedia's possession
regarding each proposed transaction."(124)
As a starting point, the Court will briefly describe in chronological
order the events in question from the perspective of the independent Digex
directors. At midday August 30, Digex seemed headed into a three-way merger with
Global Crossing and Intermedia. At 11:00 p.m. on August 30, Ruberg called each
of the Special Committee members to inform them that WorldCom had offered $120 a
share for Digex. At this point, Global Crossing was continuing to work towards a
September 1 signing in its deal with Intermedia and Digex. In either case, Digex
stood in an enviable position. Perhaps more importantly
--------
(124) Def. Intermedia's Br. at 38.
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though, considering how things turned out, there was no reason to discuss the
applicability of Section 203 at this point in time with respect to either
transaction.(125)
At around 7:00 p.m. on August 31, the Special Committee was informed
that (i) Intermedia, not Digex, would be sold to WorldCom, and (ii) the Global
Crossing transaction was effectively dead as that company would not raise its
bid in competition with WorldCom and that Intermedia preferred the WorldCom
transaction. The independent directors immediately suspected manipulation of the
WorldCom offer by Intermedia and began to search for ways to drive the deal back
to including a bid for some or all of Digex's outstanding public shares.
Overnight, the independent directors were informed of negotiations between
WorldCom and Intermedia over the waiver of Section 203.
On the morning of September 1, the independent directors at last were
allowed direct contact with WorldCom, their prospective controlling shareholder
who had requested the Section 203 waiver. These phone calls occurred, however,
not only after the price and structure of the WorldCom-Intermedia deal had been
agreed upon, but also after the terms of the Section 203 waiver had been settled
between the interested directors and WorldCom during the preceding night.
Further symbolizing the extent of the control that the interested directors
maintained over all negotiations with WorldCom concerning the Section 203 waiver
issue, these phone calls respectively between Ebbers of WorldCom and Jalkut and
Reich of Digex and then Grothe of WorldCom and Shull and Adams of Digex came
only after Clark, Digex's
--------
(125) All parties concerned agree that by this time, negotiations with Exodus
had reached at least a temporary dead end.
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legal counsel, requested them. Also on the morning of September 1, the
independent directors received both the advice of legal counsel on the possible
applicability of Section 203 and the opinion of their financial advisors
regarding the benefits of each prospective deal. In the very short time they had
before being called into the Intermedia board meeting to hold the Digex board
meeting, the independent directors considered their options.
At the Digex board meeting, the Special Committee's legal counsel
informed the entire board of his opinion that the interested directors should
not participate in the Section 203 waiver vote. This advice was rebutted by
counsel for the interested directors, and ultimately ignored. Later, without any
debate whatsoever on the merits of the waiver or the applicability of the
statute, the full Digex board voted to grant the waiver by a divided vote of
four interested directors for and three independent directors against. In total,
there simply was no meaningful participation by any of the independent Digex
directors in the negotiations leading to the Section 203 waiver, the terms of
that waiver, or the vote itself.
Several other conclusions immediately emerge from the facts of this
matter when meshed together with the defendants' contentions and justifications.
First, regardless of whether the Special Committee actually had all the
information possessed by Intermedia in its negotiations with WorldCom over the
Section 203 issue, the four interested directors controlled the flow of all
information from WorldCom to the independent Digex directors during the hectic
negotiating period from the evening of August 30 to the morning of September 1.
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Second, given that WorldCom first sought the waiver of Section 203
during the negotiations that took place solely between WorldCom and Intermedia
during the night of August 31-September 1 and that the vote at the Digex board
meeting occurred at most roughly twelve hours later, all of the Digex directors
learned about WorldCom's demand for the Section 203 waiver only hours before the
vote granting that waiver. To make matters worse, because the interested
directors were also directors of Intermedia, they could not even devote the
little time they had before the board vote to considering their options as Digex
directors and negotiating solely in the interests of Digex. Rather, they had to
spend much, if not most, of their time considering and negotiating the terms of
the merger from the perspective of Intermedia, the actual participant in the
deal with WorldCom.
Third, in regards to the waiver of Section 203, there is almost no
evidence of any direct negotiations between any of the parties over this
provision in the deal. From the little that seems to have occurred, these
negotiations took place during the night of August 31- September 1 between the
interested directors, Sutcliffe, and the WorldCom representatives. The waiver
appears to have been agreed to, in part, in exchange for an amendment to the
Digex certificate of incorporation that would require the approval of
independent directors of any material transaction between WorldCom and Digex
after the merger. The record is silent as to exploration by the interested
parties of any other options available to Digex. That is, as it appears that
WorldCom insisted on the waiver, did any of the interested directors attempt to
withhold this request in order to see what WorldCom might offer to Digex in
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<PAGE> 65
return? Or, did the directors request concessions in addition to the certificate
amendment that might benefit Digex or Intermedia? Or, as the plaintiffs assert,
did the interested directors simply agree to this condition in the interests of
getting the deal between Intermedia and WorldCom done and only subsequently add
the provision to the merger agreement concerning the certificate amendment to
create the appearance of consideration for the Section 203 waiver? These facts
remain unclear. It is crystal clear though that the independent directors, at
the time of the negotiation over the Section 203 waiver, had absolutely no role
whatsoever.
This lack of any involvement by the Special Committee is particularly
remarkable because Intermedia continues to assert that the Special Committee was
created by Digex, specifically by the interested directors, "to evaluate the
fairness to the Digex public shareholders of any transaction which involved the
sale of [Intermedia's] Digex stock and to participate in any such
transaction."(126) As the discussion of the corporate opportunity claim above
describes, the Special Committee had no legal authority to directly block
Intermedia's decision to sell its shares in Digex. The Section 203 waiver
negotiation, however, is exactly Where the Special Committee should have been
most relevant in this whole process. But this is precisely the point at which
the Special Committee is missing in action- not through any failure of its own,
but as a result of the control by the conflicted directors over the process.
Weinberger's suggestion of either an "independent negotiating structure"
--------
(126) Def. Intermedia's Br. at 4-5.
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or "total abstention" is not to be taken lightly.(127) The mere involvement in,
or even control over, the waiver negotiations by the interested directors does
not, by itself, end this inquiry into the entire fairness of the decision to
grant the waiver. But there is a strong role under Delaware law for meaningful
independent director committees.(128) Although this Special Committee may have
been created with precisely this role in mind, it certainly was not permitted to
act in keeping with this role.
The defendants also argue that the vote itself was the result of fair
dealing. The interested directors recognized that the time frame within which
the Digex directors needed to make a decision on the Section 203 waiver was
quite short. But, they claim that this deadline was dictated by the deadline
placed by Global Crossing on its proposal. This assertion of a compressed
timetable is a key component in the defendants' argument that the negotiations
simply did not allow for a more thorough analysis of the issues at hand,
including the Section 203 waiver. At the base of this contention, defendants
maintain that the WorldCom deal had to be signed by the end of the day on
September 1 because Global Crossing had imposed a deadline on its proposed deal
of 5:00 p.m., September 1. I remain somewhat perplexed, however, as to how the
Global Crossing deadline could have any affect from the perspective of a Digex
director once it appeared that Intermedia preferred to do a deal with WorldCom.
--------
(127) Weinberger, 457 A.2d at 711.
(128) In re W. Nat'l Corp. Shareholders Litig., C.A. No. 15927, Chandler, C.
(May 22, 2000), mem. op.
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<PAGE> 67
The defendants actually state that, at the time of the Section 203
waiver vote, each Digex director knew that:
(1) Intermedia could not, and would not, approve a sale to Exodus . . .
(2) the WorldCom offer was more beneficial to Intermedia than the
Global Crossing proposal, and therefore Intermedia would not approve
the latter; (3) Global Crossing had declined to make a further bid
against WorldCom and had placed a 5:00 p.m. deadline on its existing
offer; and, (4) WorldCom had expressed its intention to keep Digex
public and refused all requests that it tender for the Digex public
shares.(129)
Since Intermedia would not allow a sale to either Exodus or Global
Crossing given the offer made by WorldCom, the 5:00 p.m. Global Crossing
deadline should have been of little or no consequence in comparison to the
decision to waive the anti-takeover protections afforded by Section 203 and any
efforts to use its leverage to explore whether WorldCom would consider a partial
or full tender offer for the outstanding Digex shares. Clearly, Intermedia
wanted to complete a deal with WorldCom as soon as possible. As the facts
illustrate, Intermedia placed time pressure on WorldCom throughout the
negotiations, not the other way around, due to the presence of Global Crossing's
offer. I see no reason why such time pressure was placed on Digex to agree to
the waiver.
By the time of the Digex meeting when the vote to waive Section 203 was
undertaken, the Digex board's role had been vastly simplified over the preceding
two days. On August 30, the Digex board was confronted with the sale of the
corporation and all the attendant analysis that goes along with that process. On
September 1, however, the only issue of any
--------
(129) Def. Intermedia's Br. at 39.
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consequence before the Digex board was the rather discrete issue of whether to
waive the protections afforded by Section 203. Independent director Jalkut
proposed that a decision on the WorldCom transaction be delayed three days to
allow CSFB time to solicit best and final offers from Exodus, Global Crossing,
and WorldCom. That proposal was defeated by a vote of four to three. The Digex
board then discussed the Section 203 waiver, but the discussion was limited to
who should be allowed to vote on the waiver, nothing more. Except for the
disagreement of counsel on this participation issue, described above, there was
absolutely no discussion whatsoever of the effect, purpose, or applicability of
Section 203 to WorldCom. The vote proceeded (four to three) and the waiver was
granted.
The defendants suggest that the independent directors had decided
before the meeting to vote against the waiver and therefore any discussion on
the merits of the waiver would have been pointless. All I can say is I certainly
hope that the interested directors thought through and decided their votes
before the Digex board meeting. Based on the record of what was discussed at the
meeting, or rather the complete lack thereof, if any of the directors based
their vote on anything that occurred at the board meeting, I doubt that the
waiver vote could even pass the most deferential business judgment review.(130)
Clearly, every individual in that room had come to a conclusion concerning their
vote based on reasons wholly apart from anything said during the meeting.
Further, considering that the four interested directors carried the vote and
were faced with a clear conflict of interest, the effect of which the two
--------
(130) See Smith v. Van Gorkom, Del. Supr., 488 A.2d 858 (1985).
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present legal counsel had just discussed and disagreed over, it is very
difficult to understand why the directors themselves did not engage in any
substantive discussion of the waiver during the Digex board meeting given their
particular circumstances.
In sum, as to whether the waiver can be described as the result of fair dealing,
the independent directors, even if we assume that they were kept fully up to
date of all material information regarding the merger negotiations, were kept
powerless to affect the waiver decision in any meaningful manner. The interested
directors not only participated in the negotiations, they controlled them. They
also denied an independent negotiating structure involving the independent
directors from participating in the WorldCom negotiations over the Section 203
waiver. The powerlessness of the independent directors extended to their ability
to vote down the proposal to waive Section 203's applicability to WorldCom.
Further, there appears to have been little substantive discussion or negotiation
of the waiver by the interested directors with WorldCom and no discussion of the
waiver with the independent directors. All of these factors are framed by the
intense time pressure placed on Digex by its corporate parent to get the
WorldCom deal done as quickly as possible regardless of any consideration of the
applicability or effect of the Section 203 waiver on Digex after the merger, or
the bargaining leverage that the Digex board might have at that moment against
not only WorldCom, but Intermedia as well. I therefore conclude that it is not
reasonably likely that defendants will be able to satisfy the fair dealing prong
of the entire fairness analysis.
2. Fair Price
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Defendants assert that the "price" of the waiver was fair. They point
out that as a result of the WorldCom-Intermedia merger, Digex (i) would gain
WorldCom's commitment to fully finance Digex's business plan and its
contemplated capital expansion even before the closing; (ii) was freed of
Intermedia's oppressive debt covenant restrictions; and (iii) would receive the
benefit of WorldCom's strong financing capacity, sales force, data centers, and
strong internet presence. Moreover, as noted above, WorldCom agreed to an
amendment of Digex's certificate of incorporation whereby any future material
transaction between WorldCom and Digex must be approved by independent Digex
directors. The defendants further contend that at the time of the vote, each
Digex director knew that there were certain constraints on Digex's ability to
negotiate freely with any of its potential suitors, including WorldCom, because
of Intermedia's desire to do a deal with WorldCom and WorldCom's refusal to
negotiate any further over Digex.
Each interested director has offered individual reasons why each of
them felt justified in his vote to waive the protections afforded by Section
203. Campbell speaks at length in his deposition of his belief that the
WorldCom-Intermedia merger would be good for the Digex minority
shareholders.(131) He also explained that he voted for the merger because, "we
had an opportunity before us . . . which was, in my opinion, very good for all
parties and that we ought to take it before [letting] this thing go any further
and deteriorate so that all parties
--------
(131) See Campbell Dep. at 125-30 (explaining the particular needs
of Digex and why WorldCom, as a new parent, could effectively
meet them).
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would be in some way further harmed.(132) In response to a question asking what
Digex received in return for the waiver of Section 203, Campbell responded that,
"what they received was a new partner with all of the advantages thereof. They
received the opportunity to amalgamate their assets in a reasonable period of
time to create more shareholder value. And they did that within the constraint
that was very similar to the Section 203 constraint, where the disinterested
shareholders of any future WorldCom/Digex amalgamation would need to opine that
it was fair in all respects."(133)
In explaining why he voted in favor of the waiver, Ruber stated, "if
the board of Intermedia was going to accept the WorldCom deal, looking at that
as a Digex board member, I wanted to grant the maximum business flexibility to
the acquiring parent to make Digex as successful as possible."(134) Ruberg also
states that he did not discuss these thought processes with anyone and, though
he did not know all of the legal ramifications of Section 203, he knew that
"it's a hell of a lot easier to take something and get a yes or no from
independent board members than it is to get a yes or no from two-thirds of the
minority stockholders."(135)
--------
(132) Campbell Dep. at 159. See also id. at 163-64 (stating that he
believed WorldCom might pull the deal if Intermedia deferred
its decision).
(133) Campbell Dep. at 168-69.
(134) Ruberg Dep. at 146-47.
(135) Id.
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Baker states that he was "very comfortable" with the WorldCom
transaction "from the standpoint of a Digex director."(136) In his deposition,
Baker discusses the benefits to Digex of the proposed merger. This discussion,
similar to the comments made by Campbell in his deposition, focuses on the
benefit Digex will receive from having such a financially strong parent in
WorldCom.(137)
Finally, Manning states that he believed, as a Digex director, that the
merger was good for Digex in the long run and in the short run.(138) Therefore,
he chose to vote in favor of the waiver. He also notes that he was aware of his
conflict of interest but took account of this conflict and voted according to
the interests of Digex alone.(139) He laid out at his deposition several factors
on which he based his conclusion that the merger was good for Digex.(140) These
factors include removing the crippling burden of Intermedia's debt from Digex
and supplying Digex with substantial web hosting facilities. In addition,
Manning states that he believed that the addition of the independent director
approval provision to the Digex certificate of incorporation was an adequate
protection for the Digex minority shareholders.(141)
--------
(136) See Baker Dep. at 91-92, 101-02, 105.
(137) See Baker Dep. at 83-84.
(138) See Manning Dep. at 243.
(139) See id. at 238-39.
(140) See id. 233-34.
(141) See id. at 246.
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Before I turn to the specifics of this fair price analysis, it is
important to emphasize exactly what was being negotiated and voted upon before
the Digex board. The discussion needs to focus on the substance of the vote,
namely, the waiver of Section 203 and all the negotiations and contemplations
related thereto. Although the attractiveness of WorldCom as a prospective
corporate parent in place of Intermedia obviously enters into the analysis, the
Digex board was not expressly voting on whether to accept WorldCom's merger
proposal. As defendants themselves argue, Digex had little practical control
over who would become its new parent. That decision ultimately lay with
Intermedia as the controlling shareholder. Rather, the decision put before the
Digex board was simply whether or not to grant WorldCom the Section 203 waiver.
That is, was whatever Digex was being offered for this waiver worth the granting
of the waiver and could Digex negotiate for more?
The trade put before the Digex board was simple: waive Section 203 and
give up the protections granted by the terms of the statute in exchange for a
stronger corporate parent who had much to offer, the certificate amendment, and
the end of the burdensome relationship with Intermedia. Was this the best deal
available? Because of the manner in which the negotiating process was handled,
it is impossible to say. Perhaps Digex could have extracted something more from
WorldCom, perhaps not. It is clear, however, that Digex had little to lose and
should have felt no immediate time pressure to make a decision that would
continue to affect the public shareholders of Digex for up to the three years
following the merger.
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The plaintiffs do not dispute that WorldCom is a good fit in many
respects, vastly superior to Intermedia in many ways, or that Digex strongly
desired to be rid of Intermedia's restrictive presence. But given Intermedia's
admittedly poor financial condition, the independent Digex directors believed
that, inevitably, Intermedia would have to sell part or all of its stake in
Digex if Intermedia was to remain solvent. Time, therefore, was strongly on the
side of Digex. Further, the certificate amendment is of some value to the Digex
minority, but clearly it is not worth the same as the Section 203 waiver, or
WorldCom would not have insisted on the waiver in the first place.
As to the specific justifications offered by the interested directors,
there is thorough discussion throughout of the reasons why WorldCom was
perceived as such a strong choice to become the new controlling shareholder of
Digex. But there are few substantive reasons given for their decision to waive
Section 203 at the point in time that the vote occurred. Campbell testified that
he believed WorldCom might pull the deal if Intermedia deferred its
decision.(142) It is unclear what basis Campbell had for this belief beyond mere
intuition. WorldCom itself stated at oral argument that it had not directly
confronted this question and therefore had no answer. Ruberg argued that the
waiver was actually in Digex's best interests in order to grant WorldCom as much
unfettered flexibility as possible.(143) If this is the case, one must question
why Digex would ever possibly need to rely on Section 203 to prevent WorldCom
from
--------
(142) Campbell Dep. at 163-64.
(143) Ruberg Dep. at 146-47.
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entering into certain transactions with it. Baker's reasons for supporting the
waiver seem to be similar to Campbell's. Manning, in addition to several of the
arguments put forward by his co-directors, also emphasizes the certificate
amendment as an adequate protection for the Digex minority shareholders, a group
whose interests supposedly were best represented by the Special Committee.(144)
Additionally, it is interesting that several of the interested
Intermedia directors referenced the concepts of long-term and short-term
shareholder value in their deposition testimony.(145) Beyond examining these
views given the recent history of the Digex stock price since the announcement
of the WorldCom-Intermedia merger (and recognizing that hindsight is 20/20), I
note that in the present merger and acquisition climate, these same individuals,
as directors of Intermedia, were quite definitive about their overriding concern
for short term shareholder value. Although the Court understands the reasons
behind this point of view, (146) it is at least ironic that a similar set of
considerations did not animate these same directors when, as Digex directors,
their focus suddenly became long-term shareholder value.
In concluding this analysis of entire fairness, it appears that the
only entity that really stood to lose should the Digex board decide to further
analyze Section 203 and vote to at least
--------
(144) See Manning Dep. at 246.
(145) Campbell Dep. at 126-28; Manning Dep. at 242-44.
(146) After all, to quote John Maynard Keynes, "In the long run, we
are all dead."
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delay the grant of the waiver by a day or two was Intermedia, not Digex. The
behavior of the interested directors in controlling both the negotiations and
vote over the Section 203 waiver surely demonstrates, in a compelling fashion,
that the waiver really did present Digex with bargaining leverage against
Intermedia and WorldCom. This leverage simply was not used- could not be
used-because of the decision of the interested directors. In the unique
circumstances here, this conduct by directors acting with a clear conflict of
interest is difficult to justify and would not seem appropriate. I conclude
preliminarily that the defendants are not reasonably likely to meet their burden
as to the entire fairness of the Digex board's decision to waive Digex's Section
203 protections and, therefore, that plaintiffs have demonstrated a reasonable
probability of success on the merits of their Section 203 claim.
V. THREAT OF IRREPARABLE HARM
AND BALANCING OF THE POTENTIAL HARM
The plaintiffs have established a likelihood of success on the merits
of their claim that the defendants breached their fiduciary duties in waiving
the protections afforded by Section 203. Now I must consider whether the
plaintiffs will suffer irreparable harm if no injunction is ordered as to that
claim.(147) I conclude that the plaintiffs have not adequately established an
immediate threat of irreparable harm as to the Section 203 waiver decision and,
for that reason, I must deny their request for preliminary injunctive relief.
--------
(147) The following discussion of irreparable harm only pertains to
the Section 203 waiver vote. For the reasons discussed above
in section III, plaintiffs' arguments regarding their
corporate opportunity claim have not established a likelihood
of success on the merits and therefore, the Court has no
reason to reach or to consider, in that context, the threat of
irreparable harm and the balance of the equities.
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As noted at the outset of this Opinion, this case has presented the
Court with an unusual request for injunctive relief on the Section 203 waiver
decision. The request for injunctive relief that would have followed had the
plaintiffs convinced this Court of the likelihood of success on the corporate
opportunity claim presents the more typical situation where preliminary
injunctive relief may be appropriate. That is, the plaintiffs asked this Court
to issue an injunction to prevent the closing of the Intermedia-WorldCom merger,
an event that has not yet occurred, in order to prevent the clear monetary-based
irreparable harm that otherwise would have befallen the minority shareholders of
Digex had the merger been allowed to close without their opportunity to sell
their shares of Digex at a premium. That is a paradigmatic example of a
threatened harm for which an injunction is uniquely tailored- an impending
transaction threatening a party with harm in the future which a Court may
prevent pending a full hearing, via injunctive relief.
In stark contrast, the Section 203 waiver decision does not present
that typical injunction situation. Here, the plaintiffs have essentially asked
the Court, via an injunction, to invalidate the September 1, 2000, vote by the
Digex board to waive the applicability of Section 203. This unusual procedural
posture-where a party seeks an injunction long after the action threatening harm
has been taken-presents two problems. First, the relief the plaintiffs request
is final; it is all the relief to which they would be entitled following a full
trial on the
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merits. It is an extraordinarily rare event for a party to obtain the equivalent
of final relief at a provisional stage of the proceedings.(148)
The second problem is related to the first, and even more troubling.
Unlike the plaintiffs' corporate opportunity claim, the offending act the
plaintiffs would like for this Court to preliminarily enjoin under the Section
203 claim has already occurred. That is, the Digex board has already voted to
waive Section 203. Given that fact, an injunction issued by this Court would
involve a retrospective, not a prospective, form of relief. In other words,
because the wrongful act has already occurred, no prospective injunctive order
can possibly be an effective remedy. In that sense, the plaintiffs' request for
a preliminary injunction against the Digex board's Section 203 decision is both
temporally impossible and jurisdictionally inappropriate.(149)
Finally, not only would an injunction be improper here where the
wrongful conduct has already occurred, but an injunction is, in my judgment,
unnecessary to fully protect the Digex minority shareholders. As the above
analysis demonstrates, there is, to put it mildly,
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(148) See Appoquinimink Education Ass'n v. Board of Education of
Appoquinimink School District, Del. Ch., C.A. No. 6391, Brown,
V.C. (April 7, 1981) (". . .[I]nterim injunctive relief is
rarely granted where the immediate result would be to allow
the applicant all the relief it might hope to gain after a
final hearing.") (citing Thomas C. Marshal, Inc. v. Holiday
Inn, Inc., Del. Ch., 174 A.2d 27 (1961)). See also Dunkin
Donuts, Inc. v. O'Connor, Del. Ch., C.A. No. 13274, Jacobs,
V.C. (April 28, 1994).
(149) See generally Wolfe and Pittenger, Section 10-2(a), 693-94,
citing 1 JL High, A Treatise On The Law Of Injunctions (4th
ed. 1905) (preliminary injunctive relief has no application
where the act complained of has already occurred). Because the
Court has determined that the plaintiffs have failed to show
irreparable harm on the Section 203 claim, the Court does not
address the balancing of the equities prong of the test for a
preliminary injunction.
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extreme uncertainty over whether Section 203 will apply to WorldCom if it
acquires Intermedia according to the merger agreement. That extreme uncertainty
is no different today than it was in late August when the WorldCom-Intermedia
transaction was being negotiated. What is now much more certain, however, is
that the Section 203 waiver decision most likely did not have the "belt and
suspenders" effect that it was intended to have. In this sense, the uncertainty
that WorldCom-Intermedia attempted to contract around, via the Section 203
waiver requirement, is an uncertainty that is clearly extant today, just as it
was in late August, and provides the plaintiffs with all the relief to which
they are entitled. Of course, given the analysis of the defendants' conduct in
securing the Section 203 waiver, under the entire fairness analysis undertaken
by this Court in Part IV, C. above, there are additional uncertainties with
which defendants must now be concerned as well.
VI. CONCLUSION
For all of the reasons assigned in this Opinion, I deny injunctive
relief as to the corporate opportunity claim because the plaintiffs fail to
demonstrate a likelihood of success on the merits of that claim. Although the
plaintiffs do demonstrate a likelihood of success on the merits of their Section
203 claim, they have not shown a threat of imminent irreparable harm. Thus, they
are not entitled to injunctive relief on this claim.
If this case goes to trial, the defendants have the burden of
establishing the entire fairness of the Section 203 waiver. This will be no
small burden, based on the evidence I have reviewed in the last week. As I have
noted in this Opinion, the current record strongly suggests that the Section 203
waiver decision was not entirely fair to the Digex minority. In the
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wake of this Opinion, the defendants' choice becomes whether they will proceed
with a WorldCom-Intermedia merger knowing that this Court seriously questions
the integrity of the Section 203 waiver decision and knowing that certain of the
defendant fiduciaries stand accused of faithless acts that under the stringent
standard of the entire fairness test, could well give rise to a range of
equitable remedies, including monetary remedies.
An Order has been entered in accordance with this decision.
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