In re Loral Communications and the Possible Antipathy Towards Activist Shareholders (Part 3)

We are discussing In re Loral and examining the trial judge's search for a fifth director who failed to meet the independence standard and therefore resulted in a board with a majority of non-independent directors.

The court found a fifth director, John Harkey, to be too connected to MHR to be independent.  Harkey served on the Special Committee considering the financing proposal from MHR.  He lost his independence mostly because of a host of personal connections, perhaps the toughest ground in Delaware for doing so.

The personal relationship?  He was a business school classmate of Rachesky, the founder of MHR.  But of course, that is an example of structural bias, the very type of evidence rejected in Beam.

The court also, however, noted that Harkey had a “long-time friendship” with Rachesky, the founder of MHR.  The long time friendship conclusion was supported by no evidence in the opinion except an isolated citation to someone named Simon, apparently the other director on the Special Committee.  It was not supported by statements from Rachesky or Harkey, the two involved in the relationship. Moreover, there was no surrounding evidence to sustain the conclusion, no examples of interaction between the two directors.  This was the very sort of evidence emphatically rejected in Beam.  As the Court noted in Beam:  "Mere allegations that they move in the same business and social circles, or a characterization that they are close friends, is not  enough to negate independence for demand excusal purposes."  845 A.2d 1040, 1052-53. 

The opinion noted that the two men served as “business resources and references for each other.”  Again, the opinion provided no example or instance where the references had actually been used.  The Chancery Court rejected the argument that the use of a director as a reference resulted in a loss of independence in In re Transkaryotic Therapies, 954 A.2d 346 (Del. Ch. 2008).  In that case, the court did so even though one director used another as a reference during the period when the challenged transaction occurred.  As the court in that case described:

• Second, plaintiffs' attempt to show Yetter's dependence on Emmens for employment is unavailing. Plaintiffs allege that Yetter "was relying on Emmens's reference for a job at the time of Emmens's October 2004 approach."  The actual record evidence, however, shows that Yetter merely included Emmens's name on a list of references submitted in connection with an application for a position with Odyssey Pharmaceuticals. There is no evidence that Emmens was actually contacted by Odyssey or any affiliate. In fact, there is no evidence whatsoever that Emmens  even knew he was listed as a reference.  Moreover, the suggestion that Yetter would sell his vote for a positive job reference is belied by the fact that Yetter--unlike Leff and Moorhead--voted affirmatively to reject the initial Shire offer of $ 31 per share. At the time of that vote, February 26, 2005, Yetter had already listed and was, according to plaintiffs, already relying on Emmens's reference. If indeed Yetter had sold his vote, it would have presumably been sold by then.

We criticized that holding.  But in any event it contained much stronger evidence of a potentially disqualifying relationship that the conclusory references in Loral. 

Finally, the opinion notes that “[b]ased on Rachesky’s recommendation, Harkey serves as a director on three boards – Loral, Leap Wireless International, Inc., and Emisphere Technologies, Inc. Unsurprisingly, MHR holds large blocks of stock in each of these companies.”   In other words, it was enough that Harkey served on boards where MHR owned shares.  No case in Delaware has ever found that this type of evidence has been sufficient to deprive a director of indpendence.  Indeed, on a number of occasions, the evidence has been specifically rejected.  See Khanna v. McMinn, 2006 Del. Ch. LEXIS 86 (Del. Ch. Nov. 7, 2005) ("Second, the Amended Complaint repeatedly alleges that McMinn (or another director) 'recruited' certain individuals to be Covad directors, that those individuals took their seats at McMinn's (or others') 'behest,' and that those individuals became directors with the other directors' 'consent and approval.' Again, conclusory allegations of this nature do not advance the Court's inquiry; they will not 'sterilize' a director's judgment with respect to demand."). 

Similarly, VC Strine has, in an earlier case, indicated that similar information was immaterial in the disclosure context. See In re Netsmart Techs., Inc. S'holders Litig., 924 A.2d 171 (Del. Ch. 2007) ("In view of the tightened definitions of independence that now prevail, I am chary about adding a judicially-imposed disclosure requirement that past interlocking board service involving a target's CEO and another independent director must always be disclosed.").

In other words, Harkey was found to lack independence using standards not typically applicable in prior cases.

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

Comments

[Guy who reads transcripts]

Your reporting is horribly uninformed. Your suggestion of Strine antipathy to activist investors is irrelevant here, because this was never a case about an activist investor. Further, an activist investor typically benefits minority investors, where in this case MHR was dealing itself an edge over the minority investors.

Please read the docs, and you will find that MHR touted Harkey and Targoff as advisors to its investors as part of its role in controlling the LORL situation. You don't need to believe Strine to see they were conflicted, MHR's own investor letters make it clear. Further, Harkey and Targoff were both soliciting investments from MHR while they were involved in the tainted Special Committee and financing process.

Strine didn't come to these conclusions because he is an idiot. He got there because the record was very strong in this case.

I am not sure how much MHR or its lawyers are paying you for this drivel, but they are probably paying too much.

[J. Robert Brown]

Dear Guy who reads transcripts:

I am familiar with both points. Your argument would be stronger if it was a bit more dispassionate.

In the case, VC Strine does little with the solicitation of business angle, relying mostly on friendship and the other factors discussed in the Blog posts. Moreover, as for "touting," MHR, according to the opinion, issued marketing materials that indicated that the two directors were "Selected Investment Advisors." Not much evidence, if you ask me, of a disqualifying business relationship and frankly not much evidence of touting. In all prior cases, the court, rather than rely on conclusory statements, actually examined the nature of the business relationships, something completely absent in this case. For all we know, the two directors actually performed no paid work for MHR.

You can dislike my conclusions, but there is little question that this case applies a different standard than prior cases and that this case involves an independence question unrelated to management and entirely related to an activist shareholder. And, we have VC Strine's own comments about what he thinks of activist shareholders.

Jay Brown