Last week, VC Laster issued a decision in In re Cloudflare Stockholder Litigation. I previously blogged about this case twice. In brief: Cloudflare is a controlled company due to its dual class stock, but that meant its founders couldn’t sell stock and also maintain control. To rectify this problem, they prevailed upon the board to propose a charter amendment that would recapitalize the company in a manner that (1) did not run afoul of Nasdaq listing rules, and (2) would allow them to both maintain their high-vote shares while selling down their economic stake.
Once upon a time, this kind of conflicted deal could only have been cleansed in Delaware by approval of an independent committee and disinterested shareholders. Before that, it could not have been cleansed at all – it would be subject to entire fairness review.
But post-SB21, all controller conflicts other than take-privates can be cleansed by independent committee, and that’s what our founders were banking on.
Precisely because there was a plausible argument that this deal could not be cleansed by independent committee, the defendants agreed to expedited proceedings and discovery. Which uncovered numerous aspects of the committee process that called into question the committee’s good faith. Notably, even if SB 21 applies, lack of good faith on the part of the independent special committee is grounds to conclude a conflict transaction is not cleansed, and therefore subject to entire fairness review.
Which led to VC Laster’s ruling last week.
The headline is, he rejected the plaintiffs’ argument that recapitalizations of this sort do not get the benefit of SB 21’s cleansing procedures – rather, looking to the statutory history, he concluded this was precisely the kind of transaction SB 21 was intended to cover.
I can’t say I blame him; the plaintiffs’ argument would, uncomfortably, mean that if a plaintiff sues for equitable relief before a transaction is completed, the cleansing required would be more onerous than if a plaintiff sues for damages after a transaction is completed, and that’s just weird.
But, now that VC Laster had evidence before him about how the special committee actually functioned, he concluded that there was a reasonable probability that it failed to act in good faith, as DGCL 144’s cleansing regime requires, and he preliminarily enjoined the recapitalization.
Now, I don’t take issue with his headline ruling, but I do disagree with aspects of how he interpreted the statute. I’m going to do a separate post on that, for the nerds who really want to do a close read of DGCL 144’s language, because it gets very very long. Update: Here is that post.
But here’s the thing. VC Laster’s ruling came down on Friday, October 16. Just one business day later – on Monday, October 19 – Meta’s board voted to recapitalize the company to create a new class of voting shares, that would allow Mark Zuckerberg to cash out some of his existing stake without diminishing his voting control.
The SEC filing has a whole song and dance about how California’s impending wealth tax was going to force him to move to avoid selling his shares to pay the bill, and so the board “bargained” to keep in in California – or wherever the company’s headquarters are – by creating nonvoting stock.
And let’s just say, because we now know that DGCL 144’s safe harbors do apply to these kinds of transactions, future plaintiffs will not get discovery into how they are negotiated. Revised Section 220 will not, in most instances, allow plaintiffs to get access to informal board materials – only the heavily lawyered formal ones which will, no doubt, detail a pristine process.
Which means plaintiffs will not be able to test the Meta board’s assertion that it was necessary to recapitalize the company to keep Zuckerberg from leaving California – before the tax bill actually passes, before it survives legal challenges, before testing alternatives like allowing him to pledge more of his stock, or pulling a Brian Niccol. (I note that the SEC filing states the board proposed creating the nonvoting stock conditional on the tax bill actually going into effect, but then Zuckerberg said, “Wait, what if another jurisdiction passes a wealth tax? Didn’t think of that, did you?” and the committee agreed).
On this, let us all remember that 10 years ago, Meta – then Facebook – pulled the exact same stunt. Zuckerberg wanted to create a class of nonvoting stock so that he could sell shares while retaining control; a special committee was formed to “negotiate” with him. But that was before SB 21, and conflict transactions with controllers required both independent committee approval and disinterested shareholder approval to avoid entire fairness review and thus trial. Facebook’s disinterested shareholders overwhelmingly rejected the recapitalization, and plaintiffs challenging the deal were able to get discovery on their way to trial – only to learn how verkakte the committee process was, and the whole idea was dropped.
This time, though, we’re expected to believe it’s all about California’s wealth tax, just at the precise moment the board can be reasonably confident shareholders will not be able to inquire about their deliberations past formal board materials.