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February 1, 2013

Chancery Court Dismisses Fiduciary Duty Claim Stemming from Sale of BJ's Wholesale Club

By John M. Jascob, J.D.

The Delaware Chancery Court has granted the defendants' motion to dismiss a direct shareholder class action against the former board of directors of BJ's Wholesale Club, Inc. for breach of their fiduciary duties in connection with the 2011 sale of all of the corporation's outstanding shares to two private equity firms. The lead plaintiffs, a collection of individual and institutional former BJ's shareholders, alleged that the Defendant directors had breached, in bad faith, their fiduciary duties of loyalty and care by agreeing to a buyout that did not provide the best available value to BJ's former shareholders. The Chancery Court ruled, however, that the bad faith inferences drawn by the plaintiffs were simply not reasonable in light of the rational explanations for the board's conduct. (In re BJ's Wholesale Club, Inc. Shareholders Litig., January 31, 2013, Noble, V.C.).

Specifically, the plaintiffs alleged that the directors were improperly motivated by financial incentives to support the buyout by Leonard Green & Partners, L.P. (LGP) and CVC Capital Partners (CVC). The plaintiffs also alleged that the directors intentionally shunned offers from other parties in order to secure a deal with LGP and CVC; knowingly ignored an inaccurate valuation analysis in the fairness opinion to create an illusion that the company was less valuable; filed a misleading and deficient proxy statement; and agreed to unreasonably preclusive deal protection measures. Additionally, the plaintiffs brought aiding and abetting claims against the buyout group, alleging that they rendered substantial assistance to the directors in their breaches of their fiduciary duties to BJ's former shareholders.

The court held, however, that the facts alleged in the complaint failed to show that either: (1) the majority of the board was not both disinterested and independent; or (2) the board did not act in good faith. The plaintiffs did not seriously challenge the disinterestedness and independence of the board, the court found, noting that the buyout was approved by all nine of BJ's directors, while four of the six disinterested directors were members of the special committee that ultimately recommended the transaction. Moreover, the plaintiffs did not make any well-pleaded allegations that the six disinterested directors were somehow dominated or controlled by the two allegedly interested directors, or offer any facts to buttress their claim that they were influenced by management. Accordingly, the plaintiffs failed to plead a duty of loyalty claim against the directors arising from any disabling interest or lack of independence.

The court also found that the complaint did not allege facts to support a reasonable inference that the board consciously disregarded its so-called Revlon duties to obtain the best price. The court noted that the board had met regularly to discuss strategic alternatives and had formed an independent special committee to steer the process. The special committee then retained its own financial and legal advisors, conducted a publicized review of strategic alternatives, and met with every party which made a serious overture. Moreover, after receiving only one formal offer for $50 per share, the board drove the price up before agreeing to the buyout group's "best and final offer" of $51.25, while also negotiating some favorable deal terms, including a fiduciary out clause and a reverse termination fee.

The plaintiffs also failed to allege that the board's decision to sell the company was so far beyond the bounds of reasonable judgment that it was inexplicable on any ground other than bad faith. To the extent that the plaintiffs' alleged that the board's treatment of offers by two other parties was in bad faith, the Chancery Court found that those allegations were not supported by facts sufficient to draw a reasonable inference of bad faith. Among other things, the court found that the board was under no obligation to pursue a recapitalization proposal from another party, based upon that party's speculative estimation of what the value of such a transaction would be worth to BJ's shareholders.

For similar reasons, the court also rejected the plaintiffs' contention that the board acted in bad faith by shunning an offer from a strategic competitor. Although the plaintiffs contended that the board summarily rejected the competitor's offer without due consideration, the Chancery Court found that the only reasonable inference that could be drawn from the facts was that the board had legitimate concerns about the potential antitrust risks inherent in a transaction between two of the three largest players in the warehouse club industry.

The court also rejected the plaintiffs' contentions that BJ's self-interested directors manipulated the sales process in favor of the buyout group and that the remaining directors knowingly acquiesced in the manipulation. In addition to lacking factual support in the complaint, the court found that the allegations were belied by a year-long sales process, reasonable explanations for the board's conduct with respect to the offers from the other parties, and the fact that the buyout was ultimately approved by a majority of disinterested and independent directors. Although the plaintiffs pointed to the fact that one of the interested directors had communicated with LGP prior to the formation of the special committee, the court reasoned that it fell within the business judgment of the board to determine how merger negotiations will be conducted.

The Chancery Court also declined to accept the plaintiffs' argument that the board acted in bad faith by issuing a misleading and inaccurate proxy statement that attempted to conceal the strategic competitor's interest in purchasing BJ's from its shareholders. Although knowingly issuing an inaccurate proxy statement is conduct that may qualify as bad faith under Delaware law, the court observed, the complaint failed to contain any facts suggesting that the false statement was material or would have otherwise affected a shareholder's vote. The court noted, for example, that even after the board subsequently revised the statement to disclose the competitor's interest, BJ's shareholders almost unanimously approved the buyout. Additionally, the company's subsequent truthful revision of the proxy statement militated against a finding of bad faith. Accordingly, the plaintiffs' disclosure allegations do not support a reasonable inference of bad faith.

Finally, the court was not persuaded by the plaintiff's argument that the board acted in bad faith by agreeing to a combination of deal protection devices that collectively and unreasonably precluded a higher bid. The allegedly preclusive devices in the merger agreement included a "no-shop" provision, matching and information rights, a termination fee representing 3.1% of the deal value, and a "force-the-vote" provision. The court observed, however, that these deal protection measures have routinely been upheld as reasonable under Delaware law, especially given that the board negotiated a $175 million reverse termination fee and obtained a fiduciary out clause. Moreover, the board's decision to sell the company at a 38% premium to its unaffected stock price and after a lengthy sales process was not so far beyond the bounds of reasonable judgment that it seemed essentially inexplicable on any ground other than bad faith, the court reasoned.

Attorneys: Jessica Zeldin and P. Bradford deLeeuw (Rosenthal, Monhait& Goddess), Labaton Sucharow, LLP, Motley Rice, LLC, Robbins Geller Rudman & Dowd, and Faruqi & Faruqi, LLP, for Norfolk County Retirement System, Employees' Retirement System of the Government of the Virgin Islands, Freddie Wayne Baumgartner and Maxine Phillips. Stephen C. Norman, Kevin R. Shannon and Matthew D. Stachel (Potter Anderson & Corroon, LLP) and Jeffrey B. Rudman, Daniel W. Halston, Peter A. Spaeth, Timothy J. Perla, Nolan J. Mitchell and Andrew S. Dulberg (Wilmer Cutler Pickering Hale & Dorr, LLP) for BJ's Wholesale Club, Inc. Thomas J. Shields, Leonard A. Schlesinger, Helen Frame Peters, Edmond J. English, Christine M. Cournoyer, Paul Danos, Michael J. Sheehan, R. Judson Scaggs, Jr., and Pauletta J. Brown (Morris, Nichols, Arsht & Tunnell, LLP) for Laura J. Sen and Herbert J. Zarkin. Raymond J. DiCamillo and Susan M. Hannigan (Richards, Layton & Finger), Paul C. Gluckow and Mark D. Villaverde (Simpson Thacher & Bartlett, LLP) and Blair G. Connelly and Sarah M. Lightdale (Latham & Watkins, LLP) for Leonard Green & Partners, L.P., CVC Capital Partners, Beacon Holding, Inc., and Beacon Merger Sub, Inc.

Companies: BJ's Wholesale, Inc.; Leonard Green & Partners, L.P.; CVC Capital Partners; Beacon Holdings, Inc.; Beacon Merger Sub Inc.

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