In re Trados: Chancery Court Upholds VC-Backed Board's Decision to Allocate No Merger Consideration to Common

In In re Trados Inc. Shareholders Litig., C.A. No. 1512-VCL (Del. Ch. Aug. 16, 2013), the Delaware Court of Chancery held that a VC-backed board’s approval of a merger in which the company’s common stockholders received nothing was entirely fair despite the merger having been approved as part of an unfair process in which the interests of the company’s preferred stockholders were favored over the holders of common stock.

This action arose from the July 2005 acquisition of Trados Inc. (“Trados”) by SDL plc (“SDL”) for $60 million in cash and stock. The preferred stockholders received $52.2 million as partial payment of their liquidation preference, which was triggered by the merger, and management received $7.8 million as part of a management incentive plan. The common stockholders did not receive any merger consideration.  In this case, the Trados directors made the discretionary decision to sell Trados in a transaction that triggered the preferred stockholders‘ contractual liquidation preference, a right that the preferred stockholders otherwise could not have exercised, and provided no value to the holders of Trados common stock.

Plaintiff, a common stockholder, subsequently brought this action for breach of fiduciary duty and for an appraisal of his common stock.  The plaintiff contended that the Trados board should not have approved a merger and had a fiduciary obligation to continue operating Trados on a stand-alone basis, because that alternative had the potential to maximize the value of the corporation for the ultimate benefit of the common stock.   Plaintiff’s fiduciary claims survived a motion to dismiss, and this decision followed a five-day trial in which defendants bore the burden of proving that their actions were entirely fair because six of the seven Trados directors were not disinterested and independent, making entire fairness the operative standard of review. 

In reviewing the plaintiff’s fiduciary claims, under the entire fairness standard of review, the Court focused on the two elements of an entire fairness review: fair dealing and fair price.  As to fair dealing, the Court found that the Trados board dealt unfairly with the common when negotiating and structuring the merger.   However, in contrast to the evidence on fair dealing, which decidedly favored the plaintiff, the Court found that the evidence on fair price supported defendants.  Specifically, the Court determined that, at the time the interested board majority approved the acquisition of the company by SDL, Trados common stock had no economic value, and Trados did have a realistic chance of generating a return for the holders of its common stock.  Because the test for entire fairness is not a bifurcated one as between fair dealing and price, the defendants’ evidence on price fairness was ultimately persuasive to the Court’s unitary fairness determination.

Thus, the Court found that the interested directors had no duty to continue to operate the company independently to generate value for the common stock, and the approval of a merger in which the holders of common stock received no consideration did not constitute a breach of fiduciary duty in this case.    The Court also found that the appraised value of the common stock for purposes of the appraisal proceeding was likewise zero.

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