Corporate Governance

In re Loral Communications and the Possible Antipathy Towards Activist Shareholders (Part 2)

By J. Robert Brown

We are discussing the Chancery Court's opinion in In re Loral.

In Delaware, the standard of review doesn’t depend upon the conduct involved but on the approval mechanism. For plaintiffs to successfully challenge the board’s behavior, they have to show that the board was not independent. See Opinion, at 43 (“Because MHR had effective control of the Loral board, the plaintiffs argue that MHR has the burden of showing that the MHR Financing was fair to Loral.”). This is a notoriously difficult standard to meet in Delaware. The state courts impose excessive pleading standards at the motion to dismiss/demand excusal stage and apply an unrealistic definition of independence.

In this case, the Loral board contained nine directors. Three of the nine directors were appointed by MHR. Plaintiffs, therefore, needed to show that two additional directors were not independent because of their connections to MHR. The court found that plaintiffs met the standard in what can only be viewed as surprising analysis.

One of the directors was Michael B. Targoff, the CEO and vice chairman of the board. The evidence for a lack of independence? In a letter to its investors, MHR described Targoff as an advisor. He received free office space in MHR’s midtown offices rent free in return for providing advice on “potential transactions and business opportunities.”

That’s it. The opinion was devoid of any numbers that put a value on the services or the free office space. Only one other Delaware case has found allegations of free office space to be sufficient to result in a loss of independence.  See In re infoUSA, Inc. S'holders Litig., 953 A.2d 963 (Del Ch 2007).  In that case, however, the case was at a motion to dismiss and the court agreed to allow it to go forward only because an internal memorandum suggested that the space may have deprived the directors of independence and, as a result, the need for discovery.  But the opinion noted the kind of evidence it expected to see after discovery.  "Plaintiffs have not had the benefit of discovery, however, and it would be too much to expect for plaintiffs now to provide the Court with a detailed floor-plan of the Everest offices; an estimate of the cost of office space in Omaha, Nebraska; the square footage occupied by each defendant; an estimate of the personal net worth of Haddix and Walker; and any of the various other factors that would need to be presented to establish by a preponderance of the evidence that the two directors lack independence."

VC Strine needed none of that level of specificity.  The opinion contains no information on the amount of space, the net worth of Targoff, the square footage, or anything else that suggests the type of material impairment necessary to deprive a director of independence.

Similarly, with respect to the advisory role played by Targoff, there is nothing in the opinion that suggests Targoff was actually paid any money.  Nor is there any evidence of actual advise provided.  In other words, there is no evidence that a material business relationship of any kind existed.  It is the very kind of lack of information that ordinarily gets a plaintiff’s challenge to director independence dismissed.  But in the case of a relationship with an activist shareholder, the standard of proof is apparently lower.

Add in that the opinion provides data that suggests that in fact Targoff served in an independent role. First, he worked for a predecessor for Loral for 16 years. In other words, he knew the company and was experienced in the industry. Second, even the court couldn’t avoid noting his role in the negotiations with MHR. "Sadly, by the end of the negotiation process, it appears that Loral’s CEO, Targoff, was a more aggressive negotiator than the Special Committee itself or the Committee’s financial advisor, North Point"

The opinion and a number of pleadings are filed on the DU Corporate Governace web site.

Full post as published by The Race to the Bottom on October 30, 2008 (boomark / email).