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From Securities Regulation Daily, September 1, 2016

Duke directors to answer for booting CEO upon merger closing

By Anne Sherry, J.D.

Directors of Duke Energy could face liability for their decision to oust Progress Energy’s CEO on the same day the merger between the two companies closed. According to shareholders suing derivatively, the parties agreed that the CEO would run the new company and made that representation to the utilities commission whose approval secured the merger, resulting in damages when the board reneged post-closing. Although the directors were disinterested and independent, the allegations that they violated the law deprived them of the business judgment presumption, the Delaware Court of Chancery determined in denying their motion to dismiss (In re Duke Energy Corporation Derivative Litigation, August 31, 2016, Glasscock, S.).

What Duke agreed to and what it did. Under the 2011 merger agreement between Duke Energy and Progress Energy, William Johnson, Progress’s CEO, was to become CEO of the new company. The board technically complied, signing Johnson to a CEO agreement that included a lucrative severance fee. On the day the merger closed, however, the legacy Duke directors, who composed a majority of the new entity’s board, voted to oust Johnson, over the protests of the blindsided legacy Progress directors.

This action incurred damages in two significant respects. First, the new company was bound to pay Johnson’s severance even though his tenure as CEO lasted just minutes. Second, the North Carolina Utilities Commission, which had approved the merger based in part on representations that Johnson would be installed as CEO, took action against the company. The complaint also described other damages: securities fraud class actions, a ratings downgrade, and investigations by the North Carolina Attorney General and Florida Public Service Commission.

Issue preclusion. The plaintiffs alleged that the defendants breached their fiduciary duties in a number of respects by conspiring to breach the merger agreement and concealing the planned CEO switch. Derivative suits concerning the same set of core facts have been filed in other jurisdictions, notably a suit alleging corporate waste in North Carolina state court. That suit, Krieger, was dismissed for failure to make demand on the board; under North Carolina law, the derivative plaintiffs in the Delaware action stood in privity with the plaintiffs in Krieger. Accordingly, the dismissal in Krieger collaterally estopped the plaintiffs from litigating the same issues again. Notably, the allegations of waste or breach of duty arising from the decision to enter into a contract with Johnson (implicating the severance obligations) were precluded.

Allegations of violation of law not estopped. However, the court continued, substantial allegations of the Delaware complaint do not involve that issue. Kriegerdid not impinge on allegations that the directors caused the corporation to violate the law by changing their choice of CEO and concealing that fact from the NCUC. The issue of demand excusal arising from a violation of positive law was not decided by the Krieger court. Comparing the claims in both actions made that clear: the Krieger claims accrued at the time of Johnson’s firing, which triggered the severance obligation. The claims in the Delaware complaint accrued when Duke told the NCUC that no facts had changed, or at least when the NCUC approved the merger in reliance on the misrepresentations.

Demand futility analysis. Demand futility in Krieger turned on whether the defendants could independently consider a waste claim. Under the Delaware plaintiffs’ theory, demand futility depends on whether the director defendants are able to evaluate whether the corporation should pursue damages arising from their conscious decision to mislead regulators.

Turning to this question of whether demand was excused as futile, the court discussed the two prevailing Delaware cases: Aronson and Rales. In the end, the court wrote, it did not matter to the outcome which test it used, and it is "folly" to consider the two cases as "the components of a binary choice." Instead, Ralesis better thought of as the general test—asking if there is a reason to doubt the directors’ impartiality in making the decision whether to litigate—while Aronsonapplies the test to a specific context.

"Directors are presumed to act in good faith, but it is never good faith to knowingly cause the corporation to violate positive law." The plaintiffs’ allegations raised a reasonable probability that Duke violated a North Carolina statute that makes it a misdemeanor to knowingly or willfully give false information to the NCUC or to withhold information from the NCUC. If the defendants caused Duke to violate that provision, they would be liable. Such bad faith strips the defendants of the business judgment presumption and requires them to justify their actions; in such an action, there is reason to doubt their impartiality, and demand is excused under Rales. The court denied the motion to dismiss the bad-faith-related claims for lack of standing, but deferred decision on a motion to dismiss for failure to state a claim.

The case is No. 7705-VCG.

Attorneys: Ronald A. Brown, Jr. (Prickett, Jones & Elliott, P.A.) for Richard A. Bernstein. Kenneth J. Nachbar (Morris, Nichols, Arsht & Tunnell LLP) and Jack B. Jacobs (Sidley Austin LLP) for Duke Energy Corp. and James E. Rogers.

Companies: Duke Energy Corp.

MainStory: TopStory CorporateGovernance DirectorsOfficers FiduciaryDuties FraudManipulation MergersAcquisitions DelawareNews NorthCarolinaNews

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