Securities Snapshot
February 9, 2021

Delaware Court of Chancery Allows Stockholder Litigation to Proceed Against Viacom-CBS Over $30B Merger

Delaware Court of Chancery Allows Stockholder Litigation to Proceed Against Viacom-CBS Over $30B Merger; Ninth Circuit Affirms Dismissal with Prejudice of Securities Class Action Against Tesla; Second Circuit Affirms Dismissal of Securities Action Against Spencer Capital as Predominantly Foreign; Delaware Supreme Court Finds That Former Spectra Energy Shareholder Has Standing to Challenge Validity of Merger Price Based on Derivative Action Against Target Entity; Third Circuit Reverses Fraud Convictions Related to Regulatory Loan Reporting Requirements for “Past Due” Loans.

On January 27, 2021, in In re CBS Corporation Stockholder Class Action and Derivative Litigation, the Delaware Court of Chancery partially denied a motion to dismiss in a class action suit brought by stockholders against ViacomCBS, CBS Board members and executives, National Amusements, Inc., and Shari Redstone.

This case arises out of the 2019 merger between Viacom, Inc. (“Viacom”) and CBS Corporation (“CBS”).  Prior to the merger, both CBS and Viacom were controlled by National Amusements, Inc. (“NAI”), which was, and continues to be, controlled by Shari Redstone.  As alleged in the complaint, after assuming control of NAI in 2016, Redstone made several attempts between 2016 and 2019 to merge Viacom and CBS.  As a result of Redstone’s second unsuccessful attempt to merge the two companies in 2018, a CBS special committee sued NAI and Redstone, among others, asserting breach of fiduciary duty claims.  NAI and Redstone countersued CBS, and the litigation was ultimately settled in September 2018.  Under the terms of the settlement, several CBS board members resigned and Redstone and NAI were prohibited from proposing a merger between CBS and Viacom for two years.  However, just months later, Redstone and CBS’s new President and Acting CEO, Joseph Ianniello, met to discuss a third merger attempt.  As alleged in the complaint, Ianniello’s compensation was increased soon thereafter.  CBS and Viacom then engaged in a renewed set of negotiations and ultimately agreed to merge.  When the merger was announced in August 2019, CBS’s Class B stock price declined.

Various CBS stockholders filed complaints in the Delaware Court of Chancery related to the merger without first serving a pre-suit demand on CBS, and those lawsuits were consolidated by the court.  Plaintiffs’ consolidated amended complaint asserts claims for breach of fiduciary duty, waste, and unjust enrichment against Redstone, NAI, Ianniello, CBS’s directors, and others, primarily alleging that defendants “engineer[ed]” a merger between the two companies NAI controlled to “bail out Viacom,” and provided inadequate consideration to CBS stockholders.  

Defendants moved to dismiss the complaint in its entirety and the court largely denied the motions.  The court first held that plaintiffs’ disclosure claims concerning CBS’s proxy statement for the merger were not justiciable.  Plaintiffs had alleged that the proxy statement contained material omissions, as a result of which CBS’s stockholders were not given a full and fair opportunity to decide whether to sell their shares prior to the merger.  The court held that plaintiffs improperly pleaded this claim as a class action, which is impermissible under Delaware Supreme Court precedent.  The court also held that this claim was grounded in fraud and that plaintiffs failed to meet the heightened standard for pleading fraud.

The court then turned to the fiduciary duty claims.  The court declined to decide whether these claims were direct or derivative, and thus whether plaintiffs were required to comply with Court of Chancery Rule 23.1 and either make a pre-suit demand or plead demand futility.  Assuming without deciding that the claims were derivative, the court held that the plaintiffs had sufficiently pleaded demand futility by alleging that a majority of the relevant board members faced a substantial likelihood of liability stemming from the merger.  In conducting the demand futility analysis, the court analyzed the claims on a claim-by-claim basis, and concluded that each claim should be reviewed under the “entire fairness” standard, rather than the more deferential “business judgment” rule.  The entire fairness standard looks at whether the transaction is fair in both process and price, while the business judgment rule simply asks whether a director acted in good faith as a reasonably prudent person acting in the best interests of the entity. 

The court concluded that the claims against NAI and Redstone were subject to the entire fairness standard because NAI and Redstone controlled CBS and “stood on both sides” of the merger.  Whether or not a control person standing on both sides of a merger is alone sufficient to trigger more exacting entire fairness review, the court also found that NAI and Redstone “extracted a non-ratable benefit from the transaction,” inasmuch as they were seeking to save Viacom.  The court also concluded that the claims against the CBS board members should be reviewed under entire fairness because the complaint pleaded facts supporting a claim that they had “breached their fiduciary duty of loyalty by favoring NAI’s interests over those of CBS’s minority stockholders.”  The court similarly determined that the entire fairness standard applied to the claims against Ianniello, as he allegedly engaged in a “quid pro quo” with Redstone regarding his compensation.  While noting that overcoming the entire fairness standard at the pleading stage “is typically a Sisyphean task for defendants,” the court found that the complaint supported inferences of both unfair price and unfair dealings.

Finally, the court found that plaintiffs had sufficiently pleaded claims related to Ianniello’s compensation, ruling that there were sufficient allegations to support a claim that Ianniello was compensated not for his service to the company, but rather for his support of the merger.  


On January 26, 2021, in Wochos v. Tesla, Inc., the Ninth Circuit affirmed the lower court’s dismissal with prejudice of a putative class action brought against Tesla, Inc., and two of its officers.

On behalf of the putative class, plaintiff alleged that Tesla made a number of false and misleading statements in 2017 regarding its production capacity for the company’s first mass-market electric car, known as the Model 3.  According to the complaint, on May 3, 2017, Tesla announced 2017 production goals for the Model 3, estimating that at some point in 2017 it would produce 5,000 cars per week, which plaintiffs alleged Tesla knew it would not be able to meet. In the subsequent months, Tesla repeatedly reaffirmed that it was “on track” to meet its goal and that there were “no issues” preventing the company from achieving the goal, even though Tesla was allegedly aware of numerous obstacles, including problems creating the automatic assembly line necessary to manufacture the cars, as well as difficulties manufacturing the batteries.  The United States District Court for the Northern District of California granted defendants’ motion to dismiss with prejudice, finding that the plaintiffs had failed to plead a material misrepresentation that was outside the PSLRA’s “safe harbor,” under which forward-looking statements are not actionable if they are accompanied by meaningful cautionary language or made without actual knowledge of their falsity.

The Ninth Circuit affirmed.  The court emphasized that the definition of “forward-looking statement[s]” in SEC regulations specifically includes “plans and objectives” and “statement[s] of the assumptions” underlying such plans, and held that Tesla’s statements announcing a goal of producing 5,000 cars per week were “unquestionably” within this category.  Likewise, statements reflecting that the company was “on track” to meet this goal and that there were “no issues” that would prevent the goal’s achievement were forward-looking.  In particular, because any announcement of a goal “necessarily reflects an implicit assertion that the goal is achievable,” such “on track” statements were “merely alternative ways of declaring or reaffirming the objective itself.”  Although the plaintiffs did not specifically challenge Tesla’s cautionary statements, the court found that the statements were sufficiently meaningful to provide protection under the safe harbor.  The court concluded that a few statements at issue in the complaint were not forward-looking, such as a statement that Tesla had “started the installation of Model 3 manufacturing equipment,” but held that the complaint failed to plead sufficient facts to support an inference that those statements were false.  

Finally, the Ninth Circuit affirmed the district court’s decision to deny leave to amend.  Plaintiffs sought to add a new allegedly misleading statement by Tesla in August 2017 suggesting that the company was using an automated assembly line in July.  The Ninth Circuit held that even if plaintiffs were able to plead falsity and scienter as to this statement, they would be unable to plead loss causation because an October 2017 article disclosed that automated assembly had not begun in July, and the disclosure had not been followed by a material drop in price.


On January 25, 2021, in Cavello Bay Reinsurance Ltd. v. Stein, the Second Circuit affirmed the lower court’s dismissal of securities fraud claims against Spencer Capital Ltd. (“Spencer Capital”) and owner Kenneth Shubin Stein, finding that the suit was predominantly foreign and therefore outside the scope of Section 10(b) of the Securities Exchange Act of 1934.

Plaintiff Cavello Bay Reinsurance Ltd. (“Cavello Bay”), which is organized under Bermuda law, brought suit in the United States District Court for the Southern District of New York, alleging that Spencer Capital, a holding company also organized under Bermuda law, had violated § 10(b), Rule 10b-5 and § 20(a) of the Exchange Act, in connection with a private offering in which Cavello Bay had purchased restricted shares in Spencer Capital.  According to the complaint, Spencer Capital misrepresented its fee arrangement with its portfolio manager, Spencer Management, when negotiating with Cavello Bay.  Although Cavello Bay understood that fees paid to Spencer Management would be tied to financial gains from operational activities or returns on investment, fees were actually calculated based upon Spencer Capital’s book value.  As a result, Spencer Capital paid Spencer Management $4.4 million in fees from funds raised in the offering, despite the fact that it was operating at a loss.  Defendants moved to dismiss on the basis that the lawsuit sought an impermissible extraterritorial application of the Exchange Act. The district court granted the motion.

The Second Circuit affirmed.  The court first assumed, without deciding, that the transaction was “domestic” because the subscription agreement at issue was executed in New York. Nevertheless, the court held that the transaction was “predominantly foreign” and therefore barred.  The court emphasized that the claims at issue involved a private agreement between two Bermudan entities for shares that are not listed on a U.S. exchange or otherwise traded in the United States.  The Court noted that although the subscription agreement required Cavello Bay to register the shares with the SEC in the event of resale, this restriction was a “mere contractual impediment to resale” and did not trigger a U.S. interest that Section 10(b) was meant to protect.  The court also found that the parties’ invocation of New York law in the subscription agreement was similarly insufficient to overcome the transaction’s predominantly foreign nature.  


On January 22, 2021, in Morris v. Spectra Energy Partners (DE) GP, LP, the Delaware Supreme Court reversed the Court of Chancery’s dismissal for lack of standing in a direct action brought against Spectra Energy Partners (DE) GP, LP (“Spectra GP”), the general partner of Spectra Energy Partners L.P. (“Spectra”).  This case arises from the 2015 merger between Enbridge, Inc. (“Enbridge”) and Spectra, and plaintiff Paul Morris’s challenges to the fairness of the merger price, specifically alleging that the merger ratio, which established the price of the merger based upon the relative value of Spectra and Enbridge stock, inadequately valued his derivative claim against Spectra GP. 

Prior to the merger between Enbridge and Spectra, Spectra’s parent company, Spectra Energy Corp., entered into a venture with a third-party entity regarding two long haul natural gas pipelines.  The relevant assets were owned by Spectra, so the parties agreed to a “reverse dropdown” to sell the assets to Spectra Energy Corp.  After the reverse dropdown was authorized, Plaintiff Morris, then a shareholder of Spectra, filed a class action derivative complaint against Spectra GP, alleging, among other things, that Spectra GP’s conflicts committee who recommended approval of the “reverse dropdown” failed to comply with the partnership’s good faith obligations.  

Plaintiff Morris’s derivative action survived Spectra GP’s initial motion to dismiss, but during the discovery phase of the litigation, Enbridge acquired Spectra Energy Corp.  Thereafter, Enbridge offered a stock-for-stock buyout of Spectra’s public unitholders.  Morris’s counsel then sent a letter to Spectra GP’s conflicts committee asserting that Morris’s derivative claim was worth more than $500 million and insisting that it be considered in calculating the merger exchange ratio.  Spectra GP’s conflicts committee ultimately assigned no value to the derivative claim and the transaction was approved.  The court then dismissed the derivative claim pursuant to a stipulation by the parties.

Morris filed this class action against Spectra GP, alleging that Spectra GP breached Spectra’s limited partnership agreement and the implied covenant of good faith and fair dealing by failing to appropriately value his derivative claim in the merger exchange ratio.  The Delaware Court of Chancery dismissed the claim, finding that Morris lacked standing under the test announced in In re Primedia, Inc. Shareholders Litigation.  Under this test, to have standing to challenge a merger’s consideration based upon the company’s failure to adequately value existing derivative claims, a plaintiff must allege: (i) a derivative claim sufficient to withstand motion to dismiss scrutiny; (ii) that the claim’s value is material in relation to the merger consideration; and (iii) that the claim is not reflected in the merger consideration and will not be pursued by the buyer.

The Delaware Supreme Court reversed, finding that Plaintiff Morris did have standing to pursue his class action claims against Spectra GP.  The court reasoned that, generally, a merger extinguishes standing for an equity holder’s derivative claims on behalf of the target entity, but that such holders in certain circumstances have standing to challenge the validity of the merger itself through a direct challenge.  To determine whether Morris had standing to challenge the merger, the court applied Primedia.

The parties did not dispute that Morris’s derivative claim was viable, as it had already survived a motion to dismiss.  The parties also agreed that Enbridge did not plan to assert the claim and had assigned no value to it in the merger exchange ratio.  Instead, the dispute centered around whether the claim was material to the merger value.  The Delaware Supreme Court held that the lower court had, in evaluating materiality, improperly discounted Morris’s claim to reflect a one-in-four chance of recovery and to reflect the public unitholders’ proportionate share of that potential recovery.  The Delaware Supreme Court faulted this approach for two reasons. First, it held that courts conducting a Primedia inquiry should apply the motion to dismiss standard and accept all factual allegations as true.  The Court held that, particularly because Morris’s initial complaint had previously survived a motion to dismiss, the lower court’s application of a further litigation risk discount in assessing materiality was improper.  Second, even if the lower court properly discounted the recovery to reflect the public unitholders’ proportionate interest in a derivative recovery, the Delaware Supreme Court found that it should have compared this number to their proportional interest in the merger consideration.  Under this calculation, the Court found that the derivative claim was material to the merger price.  

After holding that Morris had standing, the Delaware Supreme Court remanded to the Court of Chancery to address the defendant’s argument that his complaint failed sufficiently to state a claim.  


On January 12, 2021, the Third Circuit reversed the 2018 convictions of four former Wilmington Trust executives in U.S. v. Harra, concluding that the company did not violate regulations that require banks to report “past due” loans.  Prosecutors charged the bank and its executives with several counts of fraud, false statements, and conspiracy to commit fraud.

Prior to the Great Recession, Wilmington Trust, a commercial real estate lender, issued short-term loans that typically financed construction projects.  Those loans gave borrowers the option to make interest-only payments until the end of the loan period, at which point the borrower could elect to repay the principal sum, or extend or refinance the loan.  In reporting “past due” loans to the SEC and Federal Reserve, it was the bank’s internal practice not to classify extended or refinanced loans as “past due.”  Although the SEC and Federal Reserve published some limited guidance, there was no clear statutory or regulatory definition of when a loan should be reported as past due.  As a result, defendants argued that the jury should be instructed that “to prove that any statement was false, the government must prove beyond a reasonable doubt that the statement was not true under any reasonable interpretation of the reporting standards.”  The trial court rejected defendants’ argument and they were found guilty on all counts.

The Third Circuit reversed, holding that it was the government’s burden to prove that a statement was false under each objectively reasonable interpretation of “past due.” The court held that the government failed to meet its burden to prove that the bank’s classification of past due loans was unreasonable based on the bank’s interpretation of regulatory guidance, and accordingly vacated defendants’ convictions.


John A. Barker 
Dylan Schweers