March 7, 2017

Massachusetts Supreme Judicial Court Rules Merger Challenges Must Be Brought Derivatively

In a decision that will have significant implications for M&A litigation involving Massachusetts corporations, on March 6, the Massachusetts Supreme Judicial Court held that a shareholder challenge to a proposed merger generally must be brought as a derivative action on behalf of the corporation.

In International Brotherhood of Electrical Workers Local No. 129 Benefit Fund v. Tucci, shareholders of EMC Corporation (EMC), a Massachusetts corporation, brought a class action asserting claims directly against EMC’s directors, alleging that the directors had breached fiduciary duties owed to both EMC and EMC’s shareholders directly in approving a $67-billion merger with Denali Holding Inc. and Dell Inc. (together, “Dell”)—the largest tech industry merger in history—in October 2015. More specifically, the plaintiffs alleged that the EMC directors breached their fiduciary duties by failing to maximize the consideration that EMC’s shareholders would receive in the merger, agreeing to merger terms that favored Dell and discouraged competing bids, and negotiating the merger under a cloud of alleged conflicts of interest. Goodwin was Massachusetts counsel for Dell in the transaction and the litigation.

The Supreme Judicial Court (Botsford, J.) affirmed a Superior Court’s order dismissing the plaintiffs’ complaint, concluding that the shareholders’ claims could only be brought derivatively on behalf of EMC, not directly. At the outset, the Court recognized that the categorization of the plaintiffs’ breach of fiduciary duty claims depended on whether the allegedly breached duties were owed to EMC shareholders or EMC. The Court further held that the answer to that question is controlled by the meaning of Section 8.30 of the Massachusetts Business Corporation Act (MBCA), which defines the standards of conduct by which directors of Massachusetts corporations must abide.

Construing the statute, the Court held that, under the statute’s plain meaning, directors’ fiduciary duties are owed only to the corporation, rejecting the plaintiffs arguments that those duties also run directly to the corporation’s shareholders and agreeing with arguments made by Dell and EMC that the Legislature intended to authorize directors to take into account the interests of other corporate constituencies besides shareholders in discharging their duties as directors in the mergers-and-acquisitions context:  “[T]he general rule of Massachusetts corporate law is that a director of a Massachusetts corporation owes a fiduciary duty to the corporation itself, and not its shareholders.” The Court acknowledged that earlier Massachusetts case law predating the MBCA had carved out two exceptions to this general rule, one for close corporations, and one for situations “where a controlling shareholder who also is a director proposes and implements a self-interested transaction that is to the detriment of minority shareholders.” Finding that neither exception applied here, the Court concluded that EMC’s directors owed fiduciary duties to EMC, and not EMC shareholders, and that the plaintiffs’ breach of fiduciary duty claims were therefore properly categorized as derivative:  “[T]he wrong alleged by the plaintiffs . . . qualifies as a direct injury to the corporation, the entity to which the director clearly owed a fiduciary duty [and] [f]lowing from that alleged injury is a claimed derivative injury to each shareholder.”

The Court acknowledged that its decision is not consistent with Delaware law, which imposes on corporate directors fiduciary duties owed directly to shareholders, but rejected the plaintiffs’ call to follow Delaware law, noting that Delaware’s General Corporation Law is materially different from the MBCA and contains no analog to Section 8.30. Finally, the Court rejected the plaintiffs’ argument that the Court’s decision was unjust because Massachusetts’ universal demand requirement—requiring that a shareholder first make a demand on the board and then allow the board between 90 and 120 days to investigate and respond—could result in a merger closing, and a plaintiff’s ownership and standing being eliminated, before a derivative suit could proceed. The Court noted that the plaintiffs had never made a demand on EMC before the merger closed and that there was no indication that derivative claims offered “a hollow or inadequate form of relief.”

Importantly, the Court’s decision reaffirms key differences between Massachusetts and Delaware corporate law. Specifically acknowledging those differences, the Court found that directors of Massachusetts corporations, unlike directors of Delaware corporations, generally do not owe fiduciary duties to shareholders. Furthermore, the Court held that under Massachusetts law, unlike Delaware law, shareholder challenges to mergers based on alleged breaches of fiduciary duty by directors generally must be brought derivatively.

The Court’s decision has important ramifications for future challenges to mergers by the shareholders of Massachusetts corporations. Because such challenges must proceed as derivative actions, shareholders will not be able to commence an action until a written demand has been made on the corporation. As the Court acknowledged, once a merger closes, the shareholders will no longer own shares in the corporation and thus will lack standing to pursue a derivative claim on behalf of the corporation. As a result, shareholders of Massachusetts corporations generally will face substantial hurdles in challenging mergers on the basis of alleged breaches of fiduciary duty by directors.