In re Trados Inc. Shareholder Litig.

David A. Jenkins, Michele C. Gott, Robert K. Beste, III, Smith, Katzenstein & Jenkins LLP, Wilmington, Delaware; Timothy J. McEvoy, Cameron McEvoy, PLLC, Fairfax, Virginia; Attorneys for Plaintiff Marc Christen. Raymond J. DiCamillo, Scott W. Perkins, Richards, Layton & Finger, P.A., Wilmington, Delaware; David J. Berger, Elizabeth M. Saunders, Steven Guggenheim, Wilson Sonsini Goodrich & Rosati, P.C., Palo Alto, California; Attorneys for Defendants David Scanlan, Lisa Stone, Sameer Gandhi, Joseph Prang, Klaus–Dieter Laidig, Joseph Campbell, and Jochen Hummel.
John L. Reed, Scott B. Czerwonka, Andrew H. Sauder, DLA Piper LLP, Wilmington, Delaware; Attorneys for Defendant Trados Inc.
OPINION

LASTER, Vice Chancellor.

TRADOS Inc. (“Trados” or the “Company”) obtained venture capital in 2000 to support a growth strategy that could lead to an initial public offering. The VC firms received preferred stock and placed representatives on the Trados board of directors (the “Board”). Afterwards, Trados increased revenue year-over-year but failed to satisfy its VC backers. In 2004, the VC directors began looking to exit. As part of that process, the Board adopted a management incentive plan (the “MIP”) that compensated management for achieving a sale even if the transaction yielded nothing for the common stock.

In July 2005, SDL plc acquired Trados for $60 million in cash and stock (the “Merger”). Under Trados's certificate of incorporation, the Merger constituted a liquidation that entitled the preferred stockholders to a liquidation preference of $57.9 million. Without the MIP, the common stockholders would have received $2.1 million. The MIP took the first $7.8 million of the Merger consideration. The preferred stockholders received $52.2 million. The common stockholders received nothing.

Directors of a Delaware corporation owe fiduciary duties to the corporation and its stockholders which require that they strive prudently and in good faith to maximize the value of the corporation for the benefit of its residual claimants. A court determines whether directors have fulfilled their fiduciary duties by evaluating the challenged decision through the lens of the applicable standard of review. Because a board majority comprised of disinterested and independent directors did not approve the Merger, the defendants had to prove that the transaction was entirely fair.

The plaintiff contended that instead of selling to SDL, the Board had a fiduciary duty to continue operating Trados independently in an effort to generate value for the common stock. Despite the directors' failure to follow a fair process and their creation of a trial record replete with contradictions and less-than-credible testimony, the defendants carried their burden of proof on this issue. Under Trados's business plan, the common stock had no economic value before the Merger, making it fair for its holders to receive in the Merger the substantial equivalent of what they had before. The appraised value of the common stock is likewise zero.

I. FACTUAL BACKGROUND

Trial took place over five days in February and March 2013. The parties introduced over 650 exhibits, submitted deposition testimony from twenty witnesses, and adduced live testimony from eight fact and two expert witnesses. Because this case did not involve a transaction to which entire fairness applied ab initio, the burden of proof rested on the plaintiff initially to prove facts sufficient to rebut one of the elements of the business judgment rule. Once the plaintiff proved that a disinterested and independent board majority did not approve the Merger, the burden shifted to the defendants to establish that their decisions were entirely fair. Having evaluated the witnesses' credibility and weighed the evidence as a whole, I find the facts to be as follows.

A. Trados's Early Days.

Defendant Jochen Hummel and Iko Knyphausen founded Trados in 1984. Hummel became Chief Technology Officer and served on the Board. Knyphausen left the Company and did not play a significant role in the case.

Trados developed proprietary desktop software for translating documents. In overly simplistic terms, the software stored a database of words and phrases. When presented with a new document, the software identified words and phrases found in its database and replaced them with their foreign counterparts.

By the late 1990s, Trados enjoyed a dominant position in the desktop translation market. To expand, Trados sought to penetrate the enterprise market. As the name suggests, customers in this market are large corporate and government enterprises whose many users run programs on a network. Trados also envisioned transitioning its products to the internet and connecting translators directly with purchasers of translation services.

At the turn of the third millennium of the Common Era, Trados sought VC funding to spur its growth and help position itself for an IPO. At the time, Trados differed significantly from the stereotypical dot-com startup. Trados had been around for sixteen years and sold a successful desktop product. In 1999, the Company generated $11.3 million in revenue and was preparing to release its first enterprise products. In 2000, Trados generated revenue of $13.9 million, representing year-over-year growth of approximately 23%.

B. Wachovia Invests In Trados.

In early 2000, Trados came to the attention of First Union Capital Partners, the predecessor to Wachovia Capital Partners, LLC (“Wachovia”). For simplicity, this decision refers only to Wachovia. Around March 2000, after conducting due diligence, Wachovia invested $5 million. Defendant David Scanlan, a Wachovia partner, sponsored the investment. In return, Wachovia received 1,801,303 shares of Series A Participating Preferred Stock (“Series A”) and 1,838,697 shares of Series B Non–Voting Convertible Preferred Stock (“Series B”), which were convertible on a 1–for–1 basis into Series A. Wachovia later converted, bringing its total Series A shares to 3,640,000. Because the conversion rendered the Series B irrelevant, this decision discusses only the Series A.

Each Series A share had an initial liquidation preference equal to its purchase price of $1.374. The stock paid a cumulative dividend at a rate of 8% per annum with unpaid dividends increasing the liquidation preference. As participating preferred, the Series A shared in any remaining distribution available for the common stock, subject to a cap not relevant to the case. At its option, Wachovia could convert the Series A into common stock pursuant to a formula in the Company's certificate of incorporation. The Series A had the right to veto any attempt by Trados to (i) amend its certificate of incorporation, (ii) authorize, issue, or reclassify shares, (iii) make, authorize, or approve dividends or distributions, (iv) redeem, repurchase, or acquire stock, (v) change the number of directors, or (vi) effect any change of control. The Series A also had the right to vote with the common stock on an as-converted basis.

As part of the investment, Wachovia obtained the right to designate a director. Wachovia designated Scanlan.

C. Hg Invests In Trados.

Around the same time, Trados came to the attention of Mercury Capital, the predecessor to Hg Capital LLP (“Hg”). For simplicity, this decision refers only to Hg. In April 2000, Hg invested $10.25 million in exchange for 5,333,330 shares of Series C Preferred Stock (“Series C”). Each Series C share had an initial liquidation preference equal to its purchase price of $1.922. Its other rights paralleled and participated pari passu with the Series A, except that the Series C was not participating preferred.

In August 2000, Hg invested an additional $2 million in exchange for 862,976 shares of Series D Preferred Stock (“Series D”). Each Series D share had an initial liquidation preference equal to its purchase price of $2.3176. Its other rights paralleled and participated pari passu with the Series C, including the cumulative dividend and veto rights. In September 2000, Hg bought 1,379,039 shares of common stock for approximately $2.3 million.

Like Wachovia, Hg obtained the right to designate a director. The relevant director for this case is defendant Lisa Stone, a partner at Hg who joined the Board in mid–2002.

D. Trados Builds Its Business.

By February 2001, Trados was attracting new, large corporate clients. In May, Trados released the latest version of its desktop software, Trados 5.

In September 2001, Wachovia and Hg made follow-on investments in Series BB Preferred Stock (“Series BB”). Wachovia paid $1.0 million for 1,007,151 shares. Hg paid $2.0 million for 2,014,302 shares. Each Series BB share had an initial liquidation preference equal to its purchase price of $0.9929. Otherwise the rights of the Series BB paralleled and participated pari passu with the Series A, including its status as participating preferred.

At the end of 2001, Trados released the MultiTerm Client Server, an enterprise product that provided a web interface for customer databases. Revenue for the year reached $15.9 million, a 14% increase over 2000, even after the negative effects of the 9/11 terrorist attacks.

E. Trados Acquires Uniscape.

Although Trados was growing and making progress in the enterprise market, management felt the Company could accelerate its growth with an acquisition. Trados focused on Uniscape, Inc., a software company with a superior enterprise product. By acquiring Uniscape, Trados hoped to gain strong enterprise development and sales teams.

Like Trados, Uniscape had received several rounds of VC funding. Uniscape's principal backer was Sequoia Capital (“Sequoia”), a prominent Silicon Valley VC firm. Through various funds, Sequoia had invested $13 million in Uniscape. Defendant Sameer Gandhi, the Sequoia partner who sponsored the Uniscape investment, served on its board.

Another member of the Uniscape board was defendant Joseph Prang, the CEO of Conformia Software, Inc. Prang and a business partner used Mentor Capital Group LLC (“Mentor”) as their investment vehicle. Through Mentor, Prang had invested approximately $700,000–750,000 of his own money in Uniscape. See Prang Dep. 17–19; Tr. 794–95.

In May 2002, Trados and Uniscape merged in a stock-for-stock transaction that valued Trados at $30 million, Uniscape at $11 million, and the post-transaction entity at $41 million. See JX 474 at 00383–91 (recording stock issuance for transaction); JX 268 at 4 (memorializing per share purchase price as liquidation preference); JX 566. International Data Corporation (“IDC”), a market research firm, described the transaction as a “win-win.” JX 75 at 4. To acquire Uniscape, Trados issued 14,806,097 shares of Series E Preferred Stock (“Series E”) to the former Uniscape stockholders, with substantially all of it going to Uniscape's preferred stockholders. Sequoia received 5,255,913 Series E shares, and Mentor received 263,810 Series E shares. Each Series E share carried an initial liquidation preference of $0.7248, equal to its effective purchase price. Its other rights paralleled and participated pari passu with the Series C.

As a result of the transaction, Sequoia wrote down its investment in Uniscape to $3.8 million. The value of Mentor's investment dropped to $191,209. The reduced amounts represented what Sequoia and Mentor actually invested in Trados. For their own purposes, however, Gandhi and Prang continued to view their investments in terms of the much larger amounts they originally invested in Uniscape.

In the transaction, Sequoia gained the ability to designate two Trados directors. Sequoia designated Gandhi and Prang.

F. Invision Invests In Trados.

In August 2002, Trados raised $2 million from Invision AG, a Swiss private equity firm. Invision received 2,350,174 shares of Series F Preferred Stock (“Series F”). Each share of Series F carried an initial liquidation preference equal to its purchase price of $0.8510. Its other terms paralleled and participated pari passu with the Series C.

Invision received the ability to designate a director and named defendant Klaus–Dieter Laidig in December 2002. Unlike Scanlan, Stone, and Gandhi, Laidig was not the Invision partner who sponsored the Trados investment. Laidig was a technology consultant who previously worked as an executive at Hewlett–Packard for over thirty years. Laidig had a part-time consulting relationship with Invision that paid him a nominal amount for handling various projects. Laidig served on the boards of two other Invision portfolio companies and advised one of Invision's funds.

G. Trados Continues To Grow Slowly.

The Board hoped that the Uniscape transaction would transform Trados. The transaction sought to unite the strengths of Trados's desktop software and Uniscape's enterprise platform, but integration difficulties plagued the combined company. Trados's desktop software programmers operated in a Microsoft environment, and their knowledge, skills, and practices were tailored to it. Uniscape's enterprise software programmers operated in a Java environment and were equally specialized. The two teams had difficulty communicating and resisted compromise. Rather than capturing synergies, Trados ended up maintaining two separate code sets and two different engineering teams.

Trados's performance in 2002 reflected these challenges. For the year, Trados generated $19.8 million in revenue, a 25% year-over-year increase, but far below the budgeted figure of $27 million. JX 95 at 4; JX 98 at 05079. In response, Trados cut costs by closing or downsizing regional offices, consolidating operations, and renegotiating leases. In January 2003, management developed a plan to combine the two code sets through Project Genesis, an effort that would “[u]nify our products on to a next generation platform” and “[d]evelop a leveraged product organization and product suite.” JX 99 at 05108. Hummel, Trados's CTO, believed completing Project Genesis was feasible and would keep Trados at the leading edge for another decade. Tr. 597–602.

Gandhi's mid-year report to his partners at Sequoia described Trados as “on track.” JX 105. He continued: “By year-end, we should have a business that can scale profitably in 2004 ... [and] ~$35M in revenue looks achievable. The government business is heating up and could account for 20–25% of revenue next year. No immediate actions are required here.” Id. Gandhi nevertheless cautioned that in terms of returns for Sequoia, Trados was unlikely to be a winner: “Within 18 months the company will be a decent acquisition target (Documentum, possibly?). Investment outlook: return capital at best. We do not own enough of the company to generate a meaningful return.” Id.

Stone gave her partners at Hg a similar mid-year evaluation of the business:

Overall, the management team is performing adequately but there are emerging issues around the HQ location, following the merger last year with Uniscape, that will need to be addressed.

The market for software sales, particularly in the enterprise arena, is tough. The business is however making reasonable progress, with some significant new customer wins and sales up 10% from last year. Overall, the business is forecasting breaking even this year.
JX 107 at 000062.

In August 2003, Invision invested another $2 million and received 2,428,513 shares of Series FF Preferred Stock (“Series FF”). Each Series FF share carried an initial liquidation preference of $0.8235, equal to its purchase price. Its other terms paralleled and participated pari passu with the Series C. That same month, Trados's management presented the Board with a detailed plan to complete Project Genesis under Hummel's leadership. See JX 114 at 02161–73. The plan showed estimated project costs of $964,150 if a portion of development was outsourced and $1,626,750 if kept in-house.

In September 2003, Trados released a new version of MultiTerm, an enterprise product that Trados described as “the most sophisticated, flexible and scaleable [sic] terminology management system on the market today” and “a powerful database solution designed to standardise [sic] terminology and distribute it throughout the enterprise over the Internet or intranet at the click of a button.” JX 120. Trados also updated its desktop product and prepared to launch TeamWorks, another enterprise product. JX 125. A Board presentation from October anticipated completing Project Genesis by the second quarter of 2005. Id. at 66.

By the end of 2003, Trados generated $24.8 million in revenue, achieving 25% year-over-year growth and making budget. Enterprise product revenue reached $3.0 million, representing more than 200% growth year-over-year. JX 137 at 10. On the downside, the Company remained unprofitable, and its cash balance declined. Stone provided her partners with another summary of the Company's mixed performance, noting that the business was making “reasonable progress.” JX 133 at 000069. Gandhi was more positive about the business:

The company made significant strides this year in preparation for greater growth in 2004. Progress includes: major upgrade to [the] management team ...; consolidation of HQ in Sunnyvale (moved management team from VA); [and] consolidation of R & D .... Management has demonstrated the ability to execute on multiple complex initiatives simultaneously. With this work complete, and with the best pipeline ever entering a new fiscal year, this company should be able to grow 50% and generate cash in 2004.
JX 129. The “major upgrade to [the] management team” included a new CFO, James Budge. But despite these positive signs, Gandhi again bluntly assessed the prospects for a significant return to Sequoia: “Unfortunately, while we might end up with an attractive software company, our ownership position makes it difficult to do much more than hope to recover a portion of invested capital.” Id.

In early 2004, with Trados coming off a record revenue year, Gandhi asked the head of software investment banking for JMP Securities (“JMP”), Kevin McClelland, to approach Trados's then-CEO, Dev Ganesan. McClelland's mission was to reach out to Ganesan and begin setting the table for a sale by discussing “opportunities for Trados in the public equities and M & A markets.” JX 139. McClelland emailed Ganesan, and the two met in person in February 2004.

H. The Board Replaces Ganesan.

During the first quarter of 2004, Trados's efforts to capture government business faltered because its three non-US directors and significant overseas equity ownership made it difficult to comply with federal contracting requirements. At a Board meeting on April 20, 2004, Ganesan detailed the Company's first quarter performance and discussed the outlook for the year. Management had projected revenue of $33 million for 2004, representing year-over-year growth of 33%. Although first quarter revenue was ahead of budget, the Company lost $2.5 million, more than expected, and Trados's cash balance fell to $6.6 million. Ganesan lowered the revenue forecast for the year from $33 million to $28 million. He then proposed maintaining headcount.

For the Board, this was a tipping point. Stone testified that the Board had been thinking about replacing Ganesan since the beginning of the year. See Tr. 688. Scanlan noted that Ganesan had consistently missed his budgets, and the directors felt the Company was running out of time. See Tr. 242–43. During the April 20 meeting, the Board terminated Ganesan. The directors appointed Hummel as Acting President, but instructed him to consult with Scanlan and Gandhi “before taking any material action on behalf of the Corporation.” JX 152. The Board tasked Scanlan with leading the search for a replacement CEO. The Board also decided to explore whether the Company could be sold in the near-term. The Board sent Hummel to meet with Trados's principal commercial relationships—Microsoft, Bowne Global Solutions (“Bowne”), and Documentum, Inc.—to explore their interest in the Company. They also decided to have JMP “test the waters” for a potential sale with a broader set of acquirers. JX 186.

Hummel struck out. In June 2004, he met with Microsoft, historically a large user of Trados's desktop product. In April 2000, to solidify the relationship, Microsoft had purchased 6,927,660 shares of Trados common stock. Microsoft listened appreciatively to Hummel's report on recent developments but made clear they had no interest in acquiring Trados. Hummel's efforts with Bowne and Documentum were similarly unsuccessful.

Gandhi took the lead on the broader market canvass. On June 24, 2004, David Silver of Santa Fe Capital Group contacted Gandhi about one of his clients, SDL, who was “prepared to make an offer” for Trados. JX 182. Gandhi quickly signed a nondisclosure agreement with Silver. Id. At the same time, Gandhi and Budge negotiated the terms of Trados's engagement of JMP. On June 30, Trados formally retained JMP to “advise [Trados] concerning opportunities for maximizing shareholder value, which may include a sale or merger of the Company.” JX 192 at 00544. The engagement letter contemplated a 1.50% transaction fee for a deal with SDL or Lionbridge Technologies, Inc. (“Lionbridge”), the two most logical acquirers, and a 1.75% transaction fee for a deal with another party. The same day, Silver introduced SDL's CEO, Mark Lancaster, to McClelland via email.

Meanwhile, Scanlan worked with an executive search firm to identify candidates for the CEO position. His efforts ultimately led to defendant Joseph Campbell, the former COO of iManage, Inc., a company in the enterprise content management space. Campbell oversaw a highly successful sale of iManage to Interwoven in 2003. Although initially not interested, Campbell became convinced that Trados represented an attractive opportunity after conducting due diligence and speaking with members of the Board.

With the dual distractions of a sale process and CEO search, the Company's business understandably faltered. Second quarter revenue came in at $5.8 million, missing budget by 8%, and Trados incurred a $1 million loss.

I. The Board Decides To Hire Campbell And Passes On A Distressed Sale.

On July 7, 2004, the Board approved hiring Campbell, and Scanlan suggested that the Board consider adopting a plan to incentivize senior executives to pursue a sale, which later became the MIP. The Board agreed, recognizing that otherwise the management team “may not have sufficient incentives to remain in the Company's service and to pursue a potential acquisition of the Company, due to the high liquidation preference of the Company's preferred stock.” JX 200 at 4.

At the same meeting, McClelland reviewed the prospects for a sale. JMP's presentation valued Trados using comparable company and comparable transaction methodologies. The comparable company analysis generated a median multiple of 2.0 times last-twelve-months (“LTM”) revenue, implying an enterprise value of approximately $55 million. The comparable transaction analysis examined seven acquisitions from July 2003 through February 2004 involving “Selected Content Management and Search Companies.” JX 198 at 15. It generated a median multiple of 2.8 times LTM revenue, implying an enterprise value of approximately $75 million. JMP's full valuation range was quite broad, extending from $20.4 million to $169.8 million.

JMP's materials identified twenty-eight potential acquirers. JX 198 at 7. In addition to SDL, which had initiated contact through Gandhi, JMP reached out to Lionbridge, Documentum, Filenet, Verity, Adobe, IBM, and Open Text. Most had no interest, and Lionbridge “terminated its discussions with the Company shortly after receiving the Company's financial statements.” JX 200 at 5. Only SDL seemed serious.

On July 15, 2004, Lancaster met with Stone to discuss SDL. She reported that Lancaster's “agenda was clearly to pursuade [sic] me that Trados is better off with [SDL] than without and that selling to them for [stock] was a good idea.” JX 208. Subsequently, Lancaster spoke with Gandhi and Scanlan by conference call. On July 26, Lancaster called McClelland and offered $40 million for the Company, consisting of $10 million in cash and $30 million in stock.

Given the low value that SDL put on the Company, the directors rejected the offer. McClelland informed SDL about the Board's “lack of interest at [the] current deal structure and valuation.” JX 227. The decision did not mean that the Board was not interested in a sale. The directors understood that the Company had stumbled and was not putting its best foot forward. A new CEO could “fix it,” particularly one with solid credentials as an operator and experience engineering a successful exit. Tr. 335.

At the end of July 2004, Scanlan and Campbell reached formal agreement on an employment package. Campbell's compensation included a base salary of $250,000, a 30% allocation of the as-yet-undocumented MIP, and options to acquire common stock representing 4% of the Company's fully diluted capitalization. His options had an exercise price “equal to the fair market value per share of the Company's Common Stock,” which the Board had determined was $0.10 per share. JX 209 at 2. Campbell also would join the Board. Gandhi reported to Sequoia on the hire:

We have recruited a hard-nosed CEO whose task is to grow this company profitably or sell it. The company has never had decent management, but with a new CEO, VP Sales, VP Marketing, and CFO in place, for the first time we will see what professional management can do. Simultaneously, [JMP] has also been retained to explore the M & A options for the business. I would expect that the company is sold within the next 18 months (perhaps sooner).
JX 172.

J. Campbell's Initial Steps.

On August 23, 2004, Campbell officially began his tenure as CEO. He quickly discovered that the Company's cash position was worse than expected and that if Trados missed sales in the third quarter by the same margin as in the second, the cash situation would become dire by year-end. See Campbell Dep. I 31–32. After just two weeks on the job, Campbell called a Board meeting.

On September 8, 2004, the directors met. After describing the Company's situation, Campbell asked the VC representatives whether their firms would provide additional capital. Each declined. See Tr. 24; Campbell Dep. I 38–39.

Campbell then sketched out two alternatives. See JX 235 at 50424. Under the first scenario, Campbell would reposition Trados in the growing enterprise content management market, where iManage had operated. This would require investing in the Company's enterprise products, developing Project Genesis, and stressing content management rather than translation services. The last aspect was largely an exercise in branding, but it could boost Trados's value because content management companies commanded higher multiples. Under this alternative, Campbell would aim for double digit top-line growth with break-even profitability in 2005. Campbell estimated that it would require $4 million in new capital. Under the second scenario, Campbell would focus on stabilizing the core business. His goal would be to achieve near-term profitability and “[e]ngage in M & A activities in December.” JX 235 at 50427. This alternative required only $2 million in new capital.

The Board declined to select either option and asked Campbell to continue refining his views. The directors authorized him to seek venture debt financing to ameliorate the immediate cash problem.

On September 22, 2004, Campbell terminated Trados's relationship with JMP. Campbell did not want a “for sale sign” on the business while he was trying to fix its operations. Tr. 17. He also felt that keeping Trados on the market too long would put downward pressure on the Company's price. It was a gentle termination, and Campbell reassured McClelland that he anticipated reengaging. See JX 236.

K. Campbell Shows What Professional Management Can Do.

With Campbell at the helm, the Company's situation began to improve. On the financing front, Campbell secured $4 million from Western Technology Investment (“Western Tech”), a provider of venture debt. Trados borrowed $2.5 million immediately and could draw the remaining $1.5 million by March 31, 2005. Western Tech charged interest of 12%, received warrants to acquire 366,000 Series FF shares immediately, and would receive additional warrants if the Company drew the balance of the venture debt. As is typical for venture debt, the loan came without any financial covenants. The Board was ecstatic; Scanlan called it a “miracle.” Tr. 333.

The Company's fourth quarter results proved Campbell's mettle as an operator. Trados generated “record” revenue of $8.7 million and achieved a “record” profit of $1.1 million. JX 322 at 4. Enterprise revenue exceeded desktop, suggesting that the repositioning effort was gaining traction.

On the M & A front, SDL's investment banker contacted Stone in November 2004. Stone emailed Campbell that the banker wanted to speak with him, even though she suggested that “the time might not be right....” JX 265. Stone explained that SDL “remained v[ery] keen on doing the Trados deal” and “wanted to ensure that a dialogue was in hand....” Id. Campbell agreed that it was “very important to somehow keep SDL ‘at the table.’ ” Id. As he explained,

They are definitely one of the three [acquirers] that could potentially represent a positive exit strategy within the Globalization Market. From a positioning standpoint, we can begin to position me as the one brought in to increase shareholder value similar to that of iManage. That way they can understand why we turned down an offer of $40 Mill[ion] but may be amenable to a future offer quite a bit higher.
Id. SDL's banker also reached out to Gandhi. See JX 271.

In December 2004, Campbell met with Lancaster. The same month, Campbell and Budge presented the MIP to the Board. The plan provided senior management with an escalating percentage of sale proceeds depending on the valuation achieved. To the extent MIP participants also received consideration as equity holders, whether through common stock or options, their MIP payout would be reduced by the amount of the consideration received. See JX 278 at 3. The cutback feature ensured that management would focus exclusively on proceeds received through the MIP rather than from their status as common stockholders. The Board allocated 30%, 12%, and 10% of the MIP to Campbell, Hummel, and Budge, respectively. All of the directors, including Campbell and Hummel, voted to approve the MIP. See JX 277.

Gandhi summarized Trados's situation at year-end in a report to his partners at Sequoia. He wrote that Campbell had done “a decent job getting the company cleaned up and organized (witness a much better 2nd half to the year)” and that “[h]is mission is to architect an M & A exit as soon as practicable.” JX 276. Gandhi remained negative about the potential returns: “Given the preference structure and likely exit valuation for this business, we unfortunately have to resign ourselves to getting a small fraction of our original Uniscape investment back.” Id. He then reassured his partners that Trados was not taking up too much of his time: “I am not spending a lot of time on this investment, even though I remain on the board.” Id.

L. Exit Discussions Intensify.

On January 10, 2005, Lancaster emailed Campbell and stated “there is sufficient potential that exists for an SDL–Trados combination” such that the two should “continue a more detailed dialogue.” JX 297. On January 17, Campbell reported to Scanlan that Lancaster was “very serious about taking next steps” and asked to meet with Stone and Scanlan before his next meeting with Lancaster. JX 298. Campbell also mentioned that he was “having another conversation” with Bowne, a major customer, and Golden Gate Capital, a private equity firm. Id.

On January 19, 2005, Campbell met with Scanlan and Stone and reviewed a presentation he had prepared entitled “Confidential M & A Discussions.” JX 291; JX 299. Campbell outlined three “Hypothes[e]s for Trados Exit,” labeled (i) Merge–Up, (ii) Harvest, and (iii) Merge–Up Adjacent. JX 291 at 3. The Merge–Up option entailed a merger with SDL, Bowne, or Lionbridge. This option was “low risk,” could be achieved within six months, and yielded valuation expectations of 1.3–1.6 times revenue based on median trading multiples of comparable companies. Id. The Harvest option contemplated a private equity firm like Golden Gate Capital acquiring both Trados and Bowne. This option was “higher risk,” could be achieved within nine months, and yielded valuation expectations “greater” than 2.0 times revenue. Id. at 3, 6. The highest risk option was Merge–Up Adjacent, which contemplated repositioning Trados as an enterprise content management provider and then achieving a merger in that space. The anticipated timeline for this option was twelve to eighteen months, and valuation expectations were less clear. The presentation did not include a stand-alone alternative.

On January 20, 2005, Campbell followed up with Scanlan, asking point blank: “What is an acceptable offer for Trados?” JX 300. Scanlan responded that “it really depends on the nature of the opportunity and the cash/stock dynamic” but promised to “give the dollar figure some thought.” Id. Shortly thereafter, Scanlan asked Campbell to prepare “a proceeds waterfall analysis by class of stock and shareholder that reflects the current ownership of the company and the management incentive plan,” and “run three sensitivities at $50 million, $60 million and $70 million.” JX 299. Scanlan said that looking at the numbers “may move along people's view[s] on our alternatives.” Id.

On January 21, 2005, Campbell updated Scanlan, Gandhi, and Stone about his discussions with Lancaster, reporting that they had a “very open and candid conversation” about “potentially putting our companies together.” JX 302. Lancaster wanted “to see the two companies together in the next 3–5 months.” Id. Lancaster also was “willing to raise cash if need be to try to acquire Trados in an effort to try to resolve the [stock] issue.” Id.

Campbell then offered his thoughts on valuation, suggesting that “we need to be realistic about the offer range.” JX 302. As Campbell saw it, “$45–$55 mil [lion] with 50%–75% in stock is where we will wind up. I also believe it's important for us to be realistic about this or any other offer. Trying to get above 2X revenue in our market is unprecedented ....” Id. Gandhi responded by asking Campbell to “optimize for true liquidity, not a higher paper valuation,” by which he meant seeking more cash even if it meant a lower nominal price. Id. Campbell replied that getting more cash would be difficult:

The original cash component from SDL was $10 mil, with $30 mil in paper. I do believe we've come a long way since then, but there is a question here on ability not desire. They claim to have the equivalent of $26 mil (US) in cash. I suggested SDL look to raising additional cash but I'm certain to make something happen with SDL ... [t]here would still be some paper component to the deal. I think it's a stretch to imagine a $45–$55 mil cash deal from anybody ....
Id. Gandhi replied that he was “ok with [Campbell's] approach,” but the group “should realize that sdl paper does in fact require a heavy duty discount.” Id. Gandhi felt that “if [Trados] can get the cash component from sdl to $30m+ and get some stock, ... that deal is very much in the ballpark for what is reasonable for a business such as ours ....” Id.

Invision directly informed Hummel, however, that it would not sell below its entry valuation of $60 million. Hummel passed this along to Campbell. Soon thereafter, the Board reached a consensus that Campbell would seek $60 million from SDL. In his first deposition, Campbell testified that “[a]t this point in time 60 was the number we were attempting to achieve and not a penny higher than that.” Campbell Dep. I 102.

M. SDL And Trados Agree On Price And Structure.

On February 2, 2005, the Board met for an update on Trados's financial performance and to consider prospects for a transaction. Campbell trumpeted the Company's fourth quarter results: (i) “$8.7 mil in total revenue!!!—record quarter,” (ii) revenue growth of 27% over the first half of 2004, and (iii) “$1.1 mil in profit from Operations—record profit.” JX 318 at 4. The presentation listed several recent product sales (including a $1.8 million deal with HP), reported that Trados “[d]elivered TeamWorks 2.0,” and indicated that offshore software development was “on track and productive.” Id. at 6. “In light of strong Q4 results,” Trados and Western Tech agreed to extend the deadline for Trados to draw the second tranche of the venture debt from March to September. Id. at 24. Campbell expected good results for the first quarter of 2005 as well, anticipating that Trados would achieve revenue of $7.1 million and do so “profitably.” Id. at 18.

Campbell then presented his stand-alone business plan for 2005–2007. He estimated the total size of the translation software market in 2004 at $170 million and Trados's “Addressable Software” market at $65 million. JX 309 at 35747. Campbell judged that Trados owned a 73% share of the desktop segment, a 58% share of the language services segment, and a 26% share of the enterprise segment. Campbell believed the bulk of Trados's addressable market—$45 million—was in enterprise software, which gave Trados some room for growth. To increase growth further, Campbell planned to reposition Trados as the dominant vendor in what he labeled the Global Information Solutions (“GIS”) market, which was Campbell's shorthand for the translation aspect of the enterprise content management space. The GIS strategy contemplated enhancing Trados's existing enterprise products to provide content management features while the Company completed Project Genesis. Campbell projected revenue of $30 million in 2005, $38 million in 2006, and $50 million in 2007, all of which assumed flat desktop revenue and growth in the enterprise and GIS segments. Campbell testified that discussion of the business plan lasted “fifteen minutes.” Campbell Dep. II 61. During depositions, the VC directors and Prang could not recall considering it. See Scanlan Dep. 129–30; Gandhi Dep. II 92–93; Stone Dep. 118–19; Prang Dep. 116. There was zero interest in funding it. See e.g., Tr. 705 (Stone).

Campbell then updated the Board on the M & A efforts: (i) SDL had made “an updated working offer in January,” (ii) a merger with Bowne would “have to wait 6–9 months,” and (iii) a merger with Lionbridge would be “possible later in the year but not likely at as high a valuation as SDL.” JX 291 at 4; JX 318 at 21; JX 319 at 00016. The Board authorized Campbell to contact Lancaster and “put a bar out there to say, look, we're not going to agree on this, ... unless you are thinking in terms of a 60–plus number ....” Campbell Dep. I 85.

On February 11, 2005, Campbell and Lancaster met, and Campbell conveyed the $60 million price. After balking initially, Lancaster agreed. The consideration would be $50 million in cash and $10 million in SDL stock. To make the price more palatable for his board, Lancaster asked that Trados pay its legal expenses and JMP's fee out of the sale proceeds. The two executives roughed out a letter of intent (the “LOI”).

Campbell shared the news with the Board. Stone sent a positive report to her partners at Hg. See JX 310 at 000033 (noting Trados “[m]ade their numbers,” “[f]inished the year well—ahead of forecast and profitable,” and that “Campbell [was] performing well”). Stone also devoted a page to the forthcoming exit, which detailed the Merger consideration and indicated it would return $15.7–19.2 million to Hg on its investment of approximately $16.6 million. Id. at 000038.

On February 14, 2005, Campbell contacted Laidig to find out whether Invision would support the deal. As the most recent investor, Invision was the least out of the money, but also the most reluctant to take a loss. Laidig said Invision would be “fine with a market cap of 60 [million],” which was their pre-money entry price. JX 332.

On February 18, 2005, Budge sent a draft of the LOI to JMP, describing the content as “pretty well baked at this point ....” JX 337. Then on February 23, Lancaster put the deal on hold after due diligence revealed Trados's poor performance during the early part of 2004. After a week of inactivity, Budge “pegged the deal odds near zero.” JX 357. On March 1, Lancaster reengaged, but Budge still thought the odds were “no better than 40%.” Id.

On March 29, 2005, Campbell updated the Board on the M & A process and reported that Bowne was “in play” with Lionbridge as the likely acquirer. JX 365. This combination would remove two of the three most likely purchasers of Trados under Campbell's low risk Merge–Up strategy. It also took away the other component (Bowne) of the Harvest strategy. From an operational perspective, it meant that one of Trados's major customers (Bowne) would be owned by a company that had been seeking aggressively to compete with Trados (Lionbridge). The deal posed a competitive threat to SDL as well, but to the extent SDL felt compelled to respond with an acquisition of its own, Trados was not its only potential target. In short, the Bowne–Lionbridge development made SDL look like the only opportunity for a near-term exit, with going it alone and the less certain Merge–Up Adjacent strategy as fallbacks.

On April 5, 2005, SDL finally responded with comments to the LOI. The purchase price and structure remained substantially the same. Campbell called a special meeting of the Board to consider the LOI. On April 8, the Board gathered via conference call, reviewed the terms of the deal, and approved it. On April 11, Campbell and Lancaster executed the LOI.

N. Trados Continues To Perform Well.

Under Campbell's leadership, Trados's fortunes continued to improve. For the first quarter of 2005, the Company brought in revenue of $7.2 million, 26% higher year-over-year and 3% over budget. JX 354. Trados achieved an operating profit of $165,000, and its cash balance exceeded $5 million, beating budget. The GIS repositioning effort was producing results. During the first quarter, the Company issued nine press releases and produced two case studies about enterprise software solutions, and three market analysts issued reports on Trados. For the quarter, enterprise software sales generated over 50% of revenue. In a report to her partners at Hg, Stone was upbeat: “For the first time, the business is ahead of budget in all key areas and has a seemingly good pipeline. Q1 was a record quarter and the business has made a profit.” JX 393 at 000051. Equally important, the “[e]xit” remained “on track.” Id.

During the second quarter of 2005, Trados continued performing. The Company again would have met its budget and shown a profit, except that Campbell and Budge agreed with Lancaster to delay shipping any new copies of Trados 7, the latest version of its desktop program, until after the Merger closed. The revenue manipulation allowed SDL to book the sales during the third quarter, post-Merger. The increased revenue for the third quarter helped Lancaster by making the acquisition immediately accretive for SDL.

During the same period, Lancaster agreed that Campbell would become President and Chief Strategy Officer of SDL. Campbell also would join SDL's board.

O. The Merger Is Approved And Closes.

On June 9, 2005, Trados's compensation committee (consisting of Gandhi, Scanlan, and Stone) approved a $250,000 bonus for Campbell and a $150,000 bonus for Budge. The bonuses were given for exemplary performance, including “[y]ear over year revenue growth exceeding market growth,” “forecast profitability” for the second quarter of 2005, and “[c]reation of three viable exit strategies for the Company.” JX 456.

On June 15, 2005, the Board met to approve the Merger. Under the MIP, the first 13% of the $60 million proceeds ($7.8 million) went to Campbell, Hummel, Budge, and other employees. Campbell's share of the MIP was 30% ($2.34 million). JX 379. During the Merger negotiations, SDL insisted that Campbell enter into a non-competition agreement, but SDL would not dig any further into its pockets to compensate him for it. To preserve the deal, Campbell agreed to the non-compete. For reasons that were not clearly developed at trial, but which I suspect are tax-related, Campbell recharacterized $1.315 million of his MIP payment as compensation for his non-competition agreement. See JX 465 at 45286. He likewise allocated $250,000 of his MIP proceeds to his bonus, which appears to have been another accommodation to keep the deal on track. As a result, Campbell nominally received only $775,000 from the MIP. See id. at 45285–86 (allocating Campbell's $2.34 million MIP payment). Unlike Campbell, Hummel demanded compensation for his non-competition agreement. His share of the MIP was duly increased from 12% to 14%. See JX 379. Hummel received $1.092 million from the MIP. See JX 465 at 45285.

At the time of the Merger, the total liquidation preference on the preferred stock was $57.9 million, including accumulated dividends. JX 465 at 45283–84. The proceeds remaining after the MIP payments—approximately $52.2 million—went to satisfy the liquidation preference. See id. at 45283. Each of the preferred stockholders received less than their full liquidation preference but more than their initial investment. The amounts recovered by the entities affiliated with the directors are shown in the following table:

+----------------------------------------------------------------------------+ ¦Preferred ¦Investment in Preferred ¦Allocated ¦ ¦ ¦ +------------+--------------------------+-----------------+----------+-------¦ ¦Stockholder ¦and Common (ex-dividends) ¦Merger Proceeds ¦Gain ¦ ¦ +------------+--------------------------+-----------------+----------+-------¦ ¦Hg ¦$16.6 million ¦$18.9 million ¦$2.3 ¦ ¦ ¦ ¦ ¦ ¦million ¦ ¦ +------------+--------------------------+-----------------+----------+-------¦ ¦Wachovia ¦$6.0 million ¦$8.1 million ¦$2.1 ¦ ¦ ¦ ¦ ¦ ¦million ¦ ¦ +------------+--------------------------+-----------------+----------+-------¦ ¦Invision ¦$4.0 million ¦$4.3 million ¦$0.3 ¦ ¦ ¦ ¦ ¦ ¦million ¦ ¦ +------------+--------------------------+-----------------+----------+-------¦ ¦Sequoia ¦$3.8 million ¦$4.4 million ¦$0.6 ¦ ¦ ¦ ¦ ¦ ¦million ¦ ¦ +------------+--------------------------+-----------------+----------+-------¦ ¦Mentor ¦$191,209 ¦$220,633 ¦$29,424 ¦ ¦ +----------------------------------------------------------------------------+
As events turned out, the preferred stockholders actually received somewhat less. Under the Merger agreement, approximately $4 million of the consideration was set aside in escrow to address indemnification claims. Only $968,000 from the escrow was dispersed to the preferred stockholders, leaving them with total proceeds of $49.2 million. The common stockholders received nothing.

At the June 15, 2005 meeting, the Board determined that the Merger was “advisable and in the best interests of the Company and its stockholders” and formally “authorized, adopted and approved” it. JX 470 at 50853. The Board also approved and recommended to stockholders an amendment to the Company's certificate of incorporation that reset the liquidation preferences of the preferred stock at the specific amounts they would receive in the Merger.

All that remained were the necessary stockholder approvals, one by the preferred and one by the common. Trados management anticipated getting both votes handily, as shown by the following table that Budge prepared and Campbell sent to Lancaster:

+---------------------------------------------------------------------------+ ¦ ¦Shareholder ¦% of Preferred ¦% of Total¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Large Friendlies: ¦ ¦ ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Hg Capital ¦23.2% ¦14.1% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Sequoia ¦14.9% ¦7.7% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Wachovia ¦13.2% ¦6.8% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Adastra ¦7.7% ¦4.0% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Invision ¦13.5% ¦7.0% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Industry Ventures ¦3.4% ¦1.8% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Mitsui ¦4.0% ¦2.1% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Jochen [Hummel] ¦0.0% ¦11.9% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Total Large Friendlies¦79.9% ¦55.4% ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------+----------------------+---------------+----------+------------¦ ¦ ¦Required Percentage ¦61.0% ¦50.0% ¦ ¦ +---------------------------------------------------------------------------+

JX 419; see JX 422 (Campbell forwarding to Lancaster).

On June 17, 2005, Trados's stockholders approved the Merger. Microsoft abstained, advising Campbell that “the economic result from the perspective of our equity interest is not such that we are prepared to actively vote in favor ....” JX 513.

P. The Plaintiff Sues.

Plaintiff Marc Christen owned about 5% of Trados's common stock. On July 21, 2005, he sought appraisal for his 1,753,298 shares.

Discovery in the appraisal action did not proceed smoothly. Christen was forced to file several motions to compel, and Trados's representations that it had completed its document production were repeatedly proven incorrect. During the appraisal action, Christen deposed Campbell, Gandhi, McClelland, Budge, Knyphausen, and Kevin Passarello, who was Trados's general counsel. Christen also defeated a motion for summary judgment.

On July 3, 2008, based on discovery from the appraisal action, Christen filed a second lawsuit, individually and on behalf of a class of Trados's common stockholders, alleging that the former Trados directors breached their duty of loyalty by approving the Merger. After the actions were consolidated, the defendants moved to dismiss the new claims and obtained a stay of discovery in both actions pending the outcome of the motion. With one exception, Chancellor Chandler denied the motion. See In re Trados Inc. S'holder Litig. ( Trados I ), 2009 WL 2225958 (Del.Ch. July 24, 2009). The exception was a claim that Campbell and Hummel manipulated Trados's shipments to benefit SDL by increasing post-Merger revenue, and that SDL and two of its principals aided and abetted this breach of duty. The Chancellor dismissed the revenue manipulation claims because the amended complaint did not adequately plead any material benefit to Campbell or Hummel. Id. at *9–10. The evidence of revenue manipulation remained relevant to the value of Trados at the time of the Merger and to the defendants' credibility. It is quite clear that revenue manipulation occurred.

In 2010, the action was reassigned to me. In the interim, discovery in the breach of fiduciary duty action had not gone smoothly either. Christen was forced to file a motion to compel, which was granted. Christen also defeated a partial motion for summary judgment. On March 11, 2011, I certified a class “consist[ing] of all beneficial owners of Trados, Inc.'s common stock whose shares were extinguished by a merger on July 7, 2005, with the exception of defendants ....” Dkt. 213. At the close of discovery, the defendants again moved for summary judgment. After the motion was denied, the case proceeded to trial.

II. LEGAL ANALYSIS

Since Cede & Co. v. Technicolor, Inc. ( Technicolor I ), 542 A.2d 1182 (Del.1988), the consolidated breach of fiduciary duty action and appraisal proceeding has been a fixture of Delaware law. The breach of fiduciary duty claim seeks an equitable remedy that requires a finding of wrongdoing. The appraisal proceeding seeks a statutory determination of fair value that does not require a finding of wrongdoing. In Technicolor I, the Delaware Supreme Court stated that when presented with such a case, the court should address the breach of fiduciary duty action first, because a finding of liability and the resultant remedy could moot the appraisal proceeding. Id. at 1188. Consistent with the Delaware Supreme Court's instructions, this decision starts with the plaintiff's claim for breach of fiduciary duty, then turns to the appraisal. It also considers the plaintiff's request for leave to file an application for fee shifting under the bad faith exception to the American Rule.

A. The Breach Of Fiduciary Duty Claim

When determining whether directors have breached their fiduciary duties, Delaware corporate law distinguishes between the standard of conduct and the standard of review. See William T. Allen, Jack B. Jacobs, & Leo E. Strine, Jr., Realigning the Standard of Review of Director Due Care with Delaware Public Policy: A Critique of Van Gorkom and its Progeny as a Standard of Review Problem, 96 Nw. U.L.Rev. 449, 451–52 (2002) [hereinafter Realigning the Standard ]. The standard of conduct describes what directors are expected to do and is defined by the content of the duties of loyalty and care. The standard of review is the test that a court applies when evaluating whether directors have met the standard of conduct. It describes what a plaintiff must first plead and later prove to prevail.

Under Delaware law, the standard of review depends initially on whether the board members (i) were disinterested and independent (the business judgment rule), (ii) faced potential conflicts of interest because of the decisional dynamics present in particular recurring and recognizable situations (enhanced scrutiny), or (iii) confronted actual conflicts of interest such that the directors making the decision did not comprise a disinterested and independent board majority (entire fairness). The standard of review may change further depending on whether the directors took steps to address the potential or actual conflict, such as by creating an independent committee, conditioning the transaction on approval by disinterested stockholders, or both. Regardless, in every situation, the standard of review is more forgiving of directors and more onerous for stockholder plaintiffs than the standard of conduct. This divergence is warranted for diverse policy reasons typically cited as justifications for the business judgment rule. See, e.g., Brehm v. Eisner, 746 A.2d 244, 263 (Del.2000) (explaining justifications for business judgment rule).

1. The Standard Of Conduct

Delaware corporate law starts from the bedrock principle that “[t]he business and affairs of every corporation ... shall be managed by or under the direction of a board of directors.” 8 Del. C. § 141(a). When exercising their statutory responsibility, the standard of conduct requires that directors seek “to promote the value of the corporation for the benefit of its stockholders.”

“It is, of course, accepted that a corporation may take steps, such as giving charitable contributions or paying higher wages, that do not maximize profits currently. They may do so, however, because such activities are rationalized as producing greater profits over the long-term.” Leo E. Strine, Jr., Our Continuing Struggle with the Idea that For–Profit Corporations Seek Profit, 47 Wake Forest L.Rev. 135, 147 n. 34 (2012) [hereinafter For–Profit Corporations ]. Decisions of this nature benefit the corporation as a whole, and by increasing the value of the corporation, the directors increase the share of value available for the residual claimants. Judicial opinions therefore often refer to directors owing fiduciary duties “to the corporation and its shareholders.” Gheewalla, 930 A.2d at 99;accord Mills Acq. Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del.1989) (“[D]irectors owe fiduciary duties of care and loyalty to the corporation and its shareholders ....”); Polk v. Good, 507 A.2d 531, 536 (Del.1986) (“In performing their duties the directors owe fundamental fiduciary duties of loyalty and care to the corporation and its shareholders.”). This formulation captures the foundational relationship in which directors owe duties to the corporation for the ultimate benefit of the entity's residual claimants. Nevertheless, “stockholders' best interest must always, within legal limits, be the end. Other constituencies may be considered only instrumentally to advance that end.” For–Profit Corporations, supra, at 147 n. 34.

A Delaware corporation, by default, has a perpetual existence. 8 Del. C. §§ 102(b)(5), 122(1). Equity capital, by default, is permanent capital. In terms of the standard of conduct, the duty of loyalty therefore mandates that directors maximize the value of the corporation over the long-term for the benefit of the providers of equity capital, as warranted for an entity with perpetual life in which the residual claimants have locked in their investment. When deciding whether to pursue a strategic alternative that would end or fundamentally alter the stockholders' ongoing investment in the corporation, the loyalty-based standard of conduct requires that the alternative yield value exceeding what the corporation otherwise would generate for stockholders over the long-term. Value, of course, does not just mean cash. It could mean an ownership interest in an entity, a package of other securities, or some combination, with or without cash, that will deliver greater value over the anticipated investment horizon. See QVC, 637 A.2d at 44 (describing how directors should approach consideration of non-cash or mixed consideration).

The duty to act for the ultimate benefit of stockholders does not require that directors fulfill the wishes of a particular subset of the stockholder base. See In re Lear Corp. S'holder Litig., 967 A.2d 640, 655 (Del.Ch.2008) ( “Directors are not thermometers, existing to register the ever-changing sentiments of stockholders.... During their term of office, directors may take good faith actions that they believe will benefit stockholders, even if they realize that the stockholders do not agree with them.”); Paramount Commc'ns Inc. v. Time Inc., 1989 WL 79880, at *30 (Del.Ch. July 14, 1989) (“The corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.”), aff'd in pertinent part, Time, 571 A.2d at 1150;TW Servs., 1989 WL 20290, at *8 n. 14 (“While corporate democracy is a pertinent concept, a corporation is not a New England town meeting; directors, not shareholders, have responsibilities to manage the business and affairs of the corporation, subject however to a fiduciary obligation.”). Stockholders may have idiosyncratic reasons for preferring decisions that misallocate capital. Directors must exercise their independent fiduciary judgment; they need not cater to stockholder whim. See Time, 571 A.2d at 1154 (“Delaware law confers the management of the corporate enterprise to the stockholders' duly elected board representatives. The fiduciary duty to manage a corporate enterprise includes the selection of a time frame for achievement of corporate goals. That duty may not be delegated to the stockholders.” (citations omitted)).

More pertinent to the current case, a particular class or series of stock may hold contractual rights against the corporation and desire outcomes that maximize the value of those rights. See MCG Capital Corp. v. Maginn, 2010 WL 1782271, at *6 (Del.Ch. May 5, 2010) (noting that preferential contract rights may appear in “the articles of incorporation, the preferred share designations, or some other appropriate document” such as a registration rights agreement, investor rights agreement, or stockholder agreement). By default, “all stock is created equal.” Id. Unless a corporation's certificate of incorporation provides otherwise, each share of stock is common stock. If the certificate of incorporation grants a particular class or series of stock special “voting powers, ... designations, preferences and relative, participating, optional or other special rights” superior to the common stock, then the class or series holding the rights is known as preferred stock. 8 Del. C. § 151(a); see Starring v. Am. Hair & Felt Co., 191 A. 887, 890 (Del.Ch.1937) (Wolcott, C.) (“The term ‘preferred stock’ is of fairly definite import. There is no difficulty in understanding its general concept. [It] is of course a stock which in relation to other classes enjoys certain defined rights and privileges.”), aff'd,2 A.2d 249 (Del.1937). If the certificate of incorporation is silent on a particular issue, then as to that issue the preferred stock and the common stock have the same rights. Consequently, as a general matter, “the rights and preferences of preferred stock are contractual in nature.” Trados I, 2009 WL 2225958, at *7;accord Judah v. Del. Trust Co., 378 A.2d 624, 628 (Del.1977) (“Generally, the provisions of the certificate of incorporation govern the rights of preferred shareholders, the certificate of incorporation being interpreted in accordance with the law of contracts, with only those rights which are embodied in the certificate granted to preferred shareholders.”).

A board does not owe fiduciary duties to preferred stockholders when considering whether or not to take corporate action that might trigger or circumvent the preferred stockholders' contractual rights. Preferred stockholders are owed fiduciary duties only when they do not invoke their special contractual rights and rely on a right shared equally with the common stock. Under those circumstances, “the existence of such right and the correlative duty may be measured by equitable as well as legal standards.” Thus, for example, just as common stockholders can challenge a disproportionate allocation of merger consideration, so too can preferred stockholders who do not possess and are not limited by a contractual entitlement. Under those circumstances, the decision to allocate different consideration is a discretionary, fiduciary determination that must pass muster under the appropriate standard of review, and the degree to which directors own different classes or series of stock may affect the standard of review.

To reiterate, the standard of conduct for directors requires that they strive in good faith and on an informed basis to maximize the value of the corporation for the benefit of its residual claimants, the ultimate beneficiaries of the firm's value, not for the benefit of its contractual claimants. In light of this obligation, “it is the duty of directors to pursue the best interests of the corporation and its common stockholders, if that can be done faithfully with the contractual promises owed to the preferred.” LC Capital, 990 A.2d at 452. Put differently, “generally it will be the duty of the board, where discretionary judgment is to be exercised, to prefer the interests of the common stock—as the good faith judgment of the board sees them to be—to the interests created by the special rights, preferences, etc .... of preferred stock.” Equity–Linked, 705 A.2d at 1042. This principle is not unique to preferred stock; it applies equally to other holders of contract rights against the corporation. Consequently, as this court observed at the motion to dismiss stage, “in circumstances where the interests of the common stockholders diverge from those of the preferred stockholders, it is possible that a director could breach her duty by improperly favoring the interests of the preferred stockholders over those of the common stockholders.” Trados I, 2009 WL 2225958, at *7;accord LC Capital, 990 A.2d at 447 (quoting Trados I and remarking that it “summarized the weight of authority very well”).

In this case, the directors made the discretionary decision to sell Trados in a transaction that triggered the preferred stockholders' contractual liquidation preference, a right that the preferred stockholders otherwise could not have exercised. The plaintiff contends that the Board should not have agreed to the Merger and had a duty to continue operating Trados on a stand-alone basis, because that alternative had the potential to maximize the value of the corporation for the ultimate benefit of the common stock. The Trados directors, of course, contend that they complied with their fiduciary duties.

2. The Standards Of Review

To determine whether directors have met their fiduciary obligations, Delaware courts evaluate the challenged decision through the lens of a standard of review. In this case, the Board lacked a majority of disinterested and independent directors, making entire fairness the applicable standard.

“Delaware has three tiers of review for evaluating director decision-making: the business judgment rule, enhanced scrutiny, and entire fairness.” Reis v. Hazelett Strip–Casting Corp., 28 A.3d 442, 457 (Del.Ch.2011). Delaware's default standard of review is the business judgment rule. The rule presumes that “in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” This standard of review “reflects and promotes the role of the board of directors as the proper body to manage the business and affairs of the corporation.” Trados I, 2009 WL 2225958, at *6. Unless one of its elements is rebutted, “the court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation's objectives.” In re Dollar Thrifty S'holder Litig., 14 A.3d 573, 598 (Del.Ch.2010). Only when a decision lacks any rationally conceivable basis will a court infer bad faith and a breach of duty.

Enhanced scrutiny is Delaware's intermediate standard of review. Framed generally, it requires that the defendant fiduciaries “bear the burden of persuasion to show that their motivations were proper and not selfish” and that “their actions were reasonable in relation to their legitimate objective.” Mercier v. Inter–Tel (Del.), Inc., 929 A.2d 786, 810 (Del.Ch.2007). Enhanced scrutiny applies to specific, recurring, and readily identifiable situations involving potential conflicts of interest where the realities of the decisionmaking context can subtly undermine the decisions of even independent and disinterested directors. In Unocal, the Delaware Supreme Court created enhanced scrutiny to address the potential conflicts of interest faced by a board of directors when resisting a hostile takeover, namely the “omnipresent specter” that target directors may be influenced by and act to further their own interests or those of incumbent management, “rather than those of the corporation and its shareholders.” 493 A.2d at 954. Tailored for this context, enhanced scrutiny requires that directors who take defensive action against a hostile takeover show (i) that “they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed,” and (ii) that the response selected was “reasonable in relation to the threat posed.” Id. at 955.

In Revlon, the Delaware Supreme Court extended the new intermediate standard to the sale of a corporation. See506 A.2d at 180–82 (expressly applying Unocal test). Here too, enhanced scrutiny applies because of the potential conflicts of interest that fiduciaries must confront. “[T]he potential sale of a corporation has enormous implications for corporate managers and advisors, and a range of human motivations, including but by no means limited to greed, can inspire fiduciaries and their advisors to be less than faithful.” In re El Paso Corp. S'holder Litig., 41 A.3d 432, 439 (Del.Ch.2012). These potential conflicts warrant a more searching standard of review than the business judgment rule:

The heightened scrutiny that applies in the Revlon (and Unocal ) contexts are, in large measure, rooted in a concern that the board might harbor personal motivations in the sale context that differ from what is best for the corporation and its stockholders. Most traditionally, there is the danger that top corporate managers will resist a sale that might cost them their managerial posts, or prefer a sale to one industry rival rather than another for reasons having more to do with personal ego than with what is best for stockholders.
Dollar Thrifty, 14 A.3d at 597 (footnote omitted). Consequently, “the predicate question of what the board's true motivation was comes into play,” and “[t]he court must take a nuanced and realistic look at the possibility that personal interests short of pure self-dealing have influenced the board ....” Id. at 598. Tailored to the sale context, enhanced scrutiny requires that the defendant fiduciaries show that they acted reasonably to obtain for their beneficiaries the best value reasonably available under the circumstances, which may be no transaction at all. See QVC, 637 A.2d at 48–49.

Entire fairness, Delaware's most onerous standard, applies when the board labors under actual conflicts of interest. Once entire fairness applies, the defendants must establish “to the court's satisfaction that the transaction was the product of both fair dealing and fair price.” Cinerama, Inc. v. Technicolor, Inc. ( Technicolor III ), 663 A.2d 1156, 1163 (Del.1995) (internal quotation marks omitted). “Not even an honest belief that the transaction was entirely fair will be sufficient to establish entire fairness. Rather, the transaction itself must be objectively fair, independent of the board's beliefs.” Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1145 (Del.Ch.2006).

To obtain review under the entire fairness test, the stockholder plaintiff must prove that there were not enough independent and disinterested individuals among the directors making the challenged decision to comprise a board majority. See Aronson, 473 A.2d at 812 (noting that if “the transaction is not approved by a majority consisting of the disinterested directors, then the business judgment rule has no application”). To determine whether the directors approving the transaction comprised a disinterested and independent board majority, the court conducts a director-by-director analysis.

In this case, the plaintiff proved at trial that six of the seven Trados directors were not disinterested and independent, making entire fairness the operative standard. This finding does not mean that the six directors necessarily breached their fiduciary duties, only that entire fairness is the lens through which the court evaluates their actions.

a. The Management Directors: Campbell And Hummel

Two of the directors—Campbell and Hummel—received personal benefits in the Merger. The plaintiff proved that the benefits were material to them, rendering Campbell and Hummel interested in the decision to approve the Merger.

In Trados I, this court recognized that “a director is interested in a transaction if ‘he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders.’ ” This court further recognized that for purposes of fiduciary review, “the benefit received by the director and not shared with stockholders must be ‘of a sufficiently material importance, in the context of the director's economic circumstances, as to have made it improbable that the director could perform her fiduciary duties ... without being influenced by her overriding personal interest.’ ” Trados I, 2009 WL 2225958, at *6 (quoting Gen. Motors Class H., 734 A.2d at 617, and citing Orman, 794 A.2d at 23).

At trial, the plaintiff proved that Campbell personally received $2.34 million from the MIP, portions of which were recharacterized as a bonus and as payment for his non-competition agreement. Campbell bargained for and obtained post-transaction employment as SDL's President and Chief Strategy Officer. He also became a member of SDL's board, where he earned $50,000 per year for his service (later bumped to $60,000 per year).

During discovery, the plaintiff asked Campbell about his personal wealth to explore materiality. Defense counsel objected, and Campbell initially refused to provide any specifics. He then only agreed to estimate that his net worth at the time was $5–10 million. Defense counsel instructed him not to answer any further questions on the subject. See Campbell Dep. II 125–27.

Campbell's post-transaction SDL board membership, standing alone, would not be sufficient to create a disqualifying interest. See Orman, 794 A.2d at 28–29. Taken collectively, however, the benefits Campbell received were material. The payments represented 23% to 47% of his net worth at the time of the Merger and paid him nearly ten times what he would make annually by continuing to manage Trados as a stand-alone entity. See, e.g., Oliver v. Bos. Univ., 2006 WL 1064169, at *27 (Del.Ch. Apr. 14, 2006) (“[The CEO], with significant financial interests of his own, cannot be said to have negotiated for the minority common shareholder because every dollar the minority common shareholder received was likely to reduce the Asset Value Realization Bonus that he would receive as a consequence of the merger.”); In re Lukens Inc. S'holders Litig., 757 A.2d 720, 730 (Del.Ch.1999), aff'd,757 A.2d 1278 (Del.2000) (treating inside director as interested in transaction because of personal financial rewards from triggering golden parachute). It is also fair to infer that the payments were material in light of defense counsel's objections and the defendants' failure to produce any countervailing evidence. See Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d 1110, 1119 n. 7 (Del.1994) ( “[T]he production of weak evidence when strong is, or should have been, available can lead only to the conclusion that the strong would have been adverse.”); Smith v. Van Gorkom, 488 A.2d 858, 878–79 (Del.1985).

At trial, the plaintiff similarly proved that Hummel personally received material benefits. Hummel's employment with Trados provided his sole source of income between 1984 and 2005; at the time of the Merger, he was earning approximately $190,000 plus an annual bonus. Hummel Dep. 132–33. SDL employed Hummel post-transaction at the same level of compensation. Tr. 667. Hummel originally was entitled to 12% of the MIP, representing $0.936 million of the Merger proceeds. Just before the Merger, Hummel complained to Campbell about some of the “strings” imposed by the MIP, such as his one year non-competition agreement. Tr. 663. After Hummel complained, his MIP percentage increased from 12% to 14% for total proceeds of $1.092 million. See JX 379; JX 465. Two days later, Budge described Hummel as “obviously a lock” to vote for the Merger. JX 390.

As with Campbell, defense counsel obstructed the plaintiff's efforts to explore the materiality of the payments to Hummel, calling it “an inappropriate area of questioning.” Hummel Dep. 163. Hummel only would estimate that his net worth at the time of the Merger was $2–4 million.

Taken collectively, the direct financial benefits Hummel received were material to him. He admitted that the $1 million payday was significant. See Hummel Dep. 164 (“A million dollars is significant, of course, yeah.”). His post-transaction employment also was a material benefit. See, e.g., In re Primedia Inc. Deriv. Litig., 910 A.2d 248, 261 n. 45 (Del.Ch.2006) (noting that compensation from employment is generally material); In re Student Loan Corp. Deriv. Litig., 2002 WL 75479, at *3 n. 3 (Del.Ch. Jan. 8, 2002) (same). The defendants' opposition to discovery warrants the same inference as with Campbell.

b. The VC Directors: Gandhi, Scanlan, And Stone

Three of the directors—Gandhi, Scanlan, and Stone—were fiduciaries for VC funds that received disparate consideration in the Merger in the form of a liquidation preference. Each faced the dual fiduciary problem identified in Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del.1983), where the Delaware Supreme Court held that there was “no dilution” of the duty of loyalty when a director “holds dual or multiple” fiduciary obligations. Id. If the interests of the beneficiaries to whom the dual fiduciary owes duties are aligned, then there is no conflict. See, e.g., Van de Walle v. Unimation, Inc., 1991 WL 29303, at *11 (Del.Ch. Mar. 7, 1991). But if the interests of the beneficiaries diverge, the fiduciary faces an inherent conflict of interest. “There is no ‘safe harbor’ for such divided loyalties in Delaware.” Weinberger, 457 A.2d at 710. The plaintiff proved at trial that Gandhi, Scanlan, and Stone faced a conflict of interest as dual fiduciaries.

In Trados I, Chancellor Chandler recognized that the VC firms' ability to receive their liquidation preference could give the VC directors a divergent interest in the Merger that conflicted with the interests of the common stock. 2009 WL 2225958, at *7. In moving to dismiss, the defendants argued that because the preferred stockholders did not receive their full liquidation preference, and because the Series A and BB were participating preferred, the preferred stockholders would benefit from a higher price and their interests were aligned with the common. Id. Chancellor Chandler rejected their argument:

Even accepting this proposition as true, however, it is not the case that the interests of the preferred and common stockholders were aligned with respect to the decision of whether to pursue a sale of the [C]ompany or continue to operate the Company without pursuing a transaction at that time.

The [M]erger triggered the $57.9 million liquidation preference of the preferred stockholders, and the preferred stockholders received approximately $52 million dollars as a result of the [M]erger. In contrast, the common stockholders received nothing as a result of the [M]erger, and lost the ability to ever receive anything of value in the future for their ownership interest in Trados. It would not stretch reason to say that this is the worst possible outcome for the common stockholders.
Id. The Chancellor held that it was “reasonable to infer from the factual allegations in the Complaint that the interests of the preferred and common stockholders were not aligned with respect to the decision to pursue a transaction that would trigger the liquidation preference of the preferred and result in no consideration for the common stockholders.” Id.; see also Equity–Linked, 705 A.2d at 1058 (observing that in contrast to common stockholders, who had an incentive to maximize the value of their shares, “the [preferred stockholders] inherently have some interest in protecting their liquidation preference”).

Although Chancellor Chandler clearly understood the point, the fact that preferred and common “may have incentives to pursue different exit strategies is not obvious.” D. Gordon Smith, The Exit Structure of Venture Capital, 53 UCLA L.Rev. 315, 356 (2005) [hereinafter Exit Structure ]. Both are equity securities which give their holders incentives to maximize value of the firm. But preferred stock carries special rights that create specific economic incentives that differ from those of common stock. VCs also operate under a business model that causes them to seek outsized returns and to liquidate (typically via a sale) even profitable ventures that fall short of their return hurdles and which otherwise would require investments of time and resources that could be devoted to more promising ventures.

i. Economic Incentives

VCs invest through preferred stock with highly standardized features, although individual details vary. VC preferred stock typically carries a preference upon liquidation, defined to include a sale of the company, that entitles the holders to receive specified value before the common stock receives anything. It usually earns a cumulative dividend which, if unpaid, steadily increases the liquidation preference. It also entitles the preferred holder to convert into common stock at a specified ratio in lieu of receiving the liquidation preference. The preferred stock in this case carried each of these features.

There is nothing inherently pernicious about the standard features of VC preferred stock. The sophisticated contract rights, the use of staged financing, and the gradual acquisition of board control over the course of multiple financing rounds help VCs reduce the risk of entrepreneur opportunism and management agency costs. See Agency Costs, supra, at 983–84; Exit Structure, supra, at 318–24; Venture Survival, supra, at 56–68. Nevertheless, “[w]hile each of the ... contracting techniques helps VC investors minimize agency risk, they also give rise to the possibility that the venture capitalist may use the contract rights opportunistically.” Robert P. Bartlett, III, Venture Capital, Agency Costs, and the False Dichotomy of the Corporation, 54 UCLA L.Rev. 37, 56 n. 78 (2006) [hereinafter False Dichotomy]; accord Ronald J. Gilson, Engineering a Venture Capital Market: Lessons from the American Experience, 55 Stan. L.Rev. 1067, 1085 (2003) (“Reducing the agency costs of the entrepreneur's discretion by transferring it to the venture capital fund also transfers to the venture capitalist ... the opportunity to use that discretion opportunistically against the entrepreneur.”).

The cash flow rights of typical VC preferred stock cause the economic incentives of its holders to diverge from those of the common stockholders. See Theory of Preferred, supra, at 1832 (noting “the preferred's financial interest is defined by contract rights that conflict intrinsically with the interests of the common”). “[T]o the extent that VCs retain their preferred stock, their cash flow rights are debt-like; to the extent that they convert, their preferred stock offers the same cash flow rights as common.” Agency Costs, supra, at 982. “Because of the preferred shareholders' liquidation preferences, they sometimes gain less from increases in firm value than they lose from decreases in firm value. This effect may cause a board dominated by preferred shareholders to choose lower-risk, lower-value investment strategies over higher-risk, higher-value investment strategies.” Id. at 994. The different cash flow rights of preferred stockholders are particularly likely to affect the choice between (i) selling or dissolving the company and (ii) maintaining the company as an independent private business. “In particular, preferred dominated boards may favor immediate ‘liquidity events' (such as dissolution or sale of the business) even if operating the firm as a stand-alone going concern would generate more value for shareholders.” In these situations, “[l]iquidity events promise a certain payout, much [or all] of which the preferred shareholders can capture through their liquidation preferences. Continuing to operate the firm as an independent company may expose the preferred-owning VCs to risk without sufficient opportunity for gain.” Agency Costs, supra, at 993–94; accord Theory of Preferred, supra, at 1886 (“Preferred, as a senior claim, will avoid taking value-enhancing risk in a case where common, as the at-the-margin residual interest, would assume the risk.”).

The distorting effects “are most likely to arise when, as is often the case, the firm is neither a complete failure nor a stunning success.” Agency Costs, supra, at 996; accord Theory of Preferred, supra, at 1833, 1875. When the venture is a stunning success (everybody wins) or a complete failure (everybody loses), the outcomes are “cut and dried.” William W. Bratton, Venture Capital on the Downside: Preferred Stock and Corporate Control, 100 Mich. L.Rev. 891, 896 (2002) [hereinafter Downside ]. But in intermediate cases, preferred stockholders have incentives to “act opportunistically.” Agency Costs, supra, at 993. “The costs of this value-reducing behavior are borne, in the first instance, by common shareholders.” Id. at 995; see Exit Structure, supra, at 351. “[B]ecause VCs in ... sales often exit as preferred shareholders with liquidation preferences that must be paid in full before common shareholders receive any payout, common shareholders may receive little (if any) payout. At the same time, the sale eliminates any ‘option value’ (upside potential) of the common stock.” Carrots & Sticks, supra, at 3.

ii. Personal Incentives

The VC business model reinforces the economic incentives that the preferred stock's cash flow rights create.

Before venture capitalists invest, they plan for exit.... The ability to control exit is crucial to the venture capitalist's business model of short-term funding of nascent business opportunities. Exit allows venture capitalists to reallocate funds and the nonfinancial contributions that accompany them .... It also allows fund investors to evaluate the quality of their venture capitalists .... Finally, the credible threat of exit by venture capitalists may work to minimize the temptation towards self-dealing by the entrepreneurs who manage the venture-backed companies.
Exit Structure, supra, at 316; see also id. at 345 (“Any venture capitalist who desires to remain in business ... must successfully raise funds, invest them in portfolio companies, then exit the companies and return the proceeds to the fund investors, who in turn are expected to reinvest in a new fund formed by the same venture capitalist ....”). The timing and form of exit are critical because VCs seek very high rates of return, usually a ten-fold return of capital over a five year period.

Three forms of exit are common. An IPO is the gold standard and most lucrative; liquidation via sale to a larger company (a trade sale) is a second-best solution; and a write-off is the least attractive. “[V]enture capitalists will sometimes liquidate an otherwise viable firm, if its expected returns are not what they (or their investors) expected, or not worth pursuing further, given limited resources and the need to manage other portfolio firms.” This may seem irrational, but “it makes perfect economic sense when viewed from the venture capitalist's need to allocate [his] time and resources among various ventures.” Venture Survival, supra, at 110 n. 218. “Although the individual company may be economically viable, the return on time and capital to the individual venture capitalist is less than the opportunity cost.” William A. Sahlman, The Structure and Governance of Venture–Capital Organizations, 27 J. Fin. Econ. 473, 507 (1990). VC firms strive to avoid a so-called “sideways situation,” also known as a “zombie company” or “the living dead,” in which the entity is profitable and requires ongoing VC monitoring, but where the growth opportunities and prospects for exit are not high enough to generate an attractive internal rate of return. These companies “are routinely liquidated,” usually via trade sales, “by venture capitalists hoping to turn to more promising ventures.”

iii. The Evidence That The VC Directors Faced A Conflict In This Case

At the pleadings stage, Chancellor Chandler recognized that it was reasonably conceivable that the VC directors faced a conflict of interest. See Trados I, 2009 WL 2225958, at *7. At trial, the plaintiff had the burden to prove on the facts of this case, by a preponderance of evidence, that (i) the interests of the VC firms in receiving their liquidation preference as holders of preferred stock diverged from the interests of the common stock and (ii) the VC directors faced a conflict of interest because of their competing duties. Cf. In re Toys “ R” Us, Inc. S'holder Litig., 877 A.2d 975, 1006 (Del.Ch.2005) (commenting that the court's “job is not to police the appearances of conflict that, upon close scrutiny, do not have a causal influence on a board's process”). The plaintiff carried his burden.

Campbell testified in his first deposition, taken on September 20, 2006, just over a year after the Merger and before anyone was sued for breach of fiduciary duty, that his mission upon joining Trados “was to help the company understand its future path, which in the mind[s] of the outside board members at that time was some type of either merger or acquisition event.” Campbell Dep. I 21; see also Tr. 117–18. Campbell perceived “degrees of aggressiveness” among the directors based on how long they had invested in Trados. Campbell Dep. I 21. From his “first week” at the Company, he perceived Gandhi as “probably the most aggressive,” Scanlan next, then Stone. Id. at 23; see also Tr. 119–22. In Campbell's assessment, “[h]alf of the board felt that we should just do something now, take the first offer.” Campbell Dep. II 20. Campbell saw Gandhi and Scanlan as the most influential board members. Campbell Dep. I 17, 25.

Consistent with Campbell's deposition testimony, the evidence at trial established that Gandhi faced a conflict and acted consistent with Sequoia's interest in exiting from Trados and moving on. As Gandhi explained at trial, when Sequoia invests, it hopes for “really fast” growth and “very large outsized returns.” Tr. 359, 411; see also Tr. 412 (explaining that Sequoia's investors will not provide the firm with money “for ten or [twelve] years for [Sequoia] to get them back 10 percent returns. You can put that in a Vanguard index fund”). Within six months after the Uniscape merger, Gandhi had concluded that Trados would not deliver outsized returns and that Sequoia's “real opportunity” was only “to recover a fraction” of its $13 million investment in Uniscape. JX 96; see also Tr. 355–62. By the end of 2002, Gandhi had decided not to put significant time into Trados beyond Board meetings and only to attend by phone unless meetings were held locally. See JX 96. From his perspective, this was simply a matter of prioritizing his time based on how Trados would perform for Sequoia relative to other opportunities with “a lot of upside.” Tr. 360–61. He later elaborated: “[M]y most, you know, limited resource is just where I'm putting my time. And it's just better to work on something brand-new that has a chance .... Is [the next Sequoia investment] going to be Google?” Tr. 397.

Gandhi saw a sale as a means of liquidating Sequoia's investment and moving on to better things. In June 2003, he told his partners at Sequoia that “[w]ithin 18 months the company will be a decent acquisition target ....” JX 105. Gandhi's investment outlook was a “return [of] capital at best.” Id. At the beginning of 2004, he put McClelland in touch with Trados's then-CEO to start setting the table for a sale. In June 2004, Gandhi reported to Sequoia that “[w]e have recruited a hard-nosed CEO whose task is to grow this company profitably or sell it” and that he expected that “the company is sold within the next 18 months (perhaps sooner).” JX 172. In early 2005, he told Sequoia that Campbell's “mission is to architect an M & A exit as soon as practicable.” JX 276. Contemporaneously, Gandhi told Campbell to “optimize for true liquidity” rather than push for greater total consideration in his discussions with SDL and that “if [Trados] can get the cash component from sdl to $30m+ and get some stock,” he thought “that deal is very much in the ballpark for what is reasonable” for Trados. JX 302.

The evidence at trial established that Scanlan had similar incentives, consistent with Campbell's deposition testimony. Wachovia was the earliest VC investor in Trados and bought in before the technology bubble popped. Scanlan sponsored the deal and saw himself as the “owner” of the investment. Scanlan Dep. 49; see also Tr. 282. In February 2001, Wachovia regarded Trados as “well positioned for an exit either through an IPO or an M & A event” and noted that Trados had “been approached by several of its competitors (Lionbridge, SDL).” JX 48 at 8. With Wachovia still invested in summer 2004, Scanlan saw a sale as the best option, even though Trados had stumbled and lacked a CEO. Despite rebuffing SDL's initial low-ball offer, Scanlan testified that the Board “never let SDL go. We knew they were the only party, and we had to figure out a way.” Tr. 335. Scanlan also recommended and designed the MIP to incentivize top management to favor a sale even at valuations where the common stock would receive zero.

Scanlan decided to leave Wachovia in late 2004 and informed Wachovia of his departure on January 5, 2005. When he told Campbell, in March or April 2005, Campbell asked him to stay on as Wachovia's designee until the SDL deal closed. Tr. 270–72, 337–38. Wachovia responded: “Please don't be disruptive. If you're willing to do it, even though you don't need to do it, if you're willing to do it, go ahead and stay on the board.” Tr. 271–72; accord JX 388 (Scanlan informed Campbell that Wachovia was “sensitive” to Campbell's “concerns regarding a board change at this juncture” and agreed to “leave [Scanlan] on the board ....”). Scanlan agreed to stay on, and his willingness to continue at Trados, even after resigning from Wachovia, demonstrates his continuing loyalty to his former employer.

As Campbell testified, Stone was the least aggressive in seeking an exit. The evidence at trial nevertheless established that Stone had the same desire to exit and faced the same conflict of interest as Gandhi and Scanlan, although she was more open to considering a sale in 12–18 months rather than pushing for a near-term outcome. Stone candidly admitted that “[a]ll private equity firms, ourselves included, are always, from the moment we buy [ ] a business, looking for an exit.” Stone Dep. 79. Indeed, when Hg invested in 2000, its investment thesis included an “explicit agreement with the management team” to pursue “an IPO in 18 to 24 months.” Id.; accord Tr. 683 (“[T]he plan was actually to do an IPO by 2002.”). In mid–2004, Hg remained invested in Trados, the Company lacked direction, and Stone felt “blind” as to Trados's options and potential. Tr. 690. She was understandably concerned: Some of Hg's “largest clients,” ones that they “have the closest relationship[s] with,” were direct investors in Trados, as were Hg Capital Trust (Hg's “publicly floated vehicle”) and some of Stone's partners at Hg. Tr. 730–32.

Stone's view on exit is best seen in her response to the business plan that Campbell presented on February 2, 2005. After Ganesan's termination, Stone felt the Board needed to understand the Company's potential before making any decisions. Tr. 688–89. She believed the Board “would be jumping the gun” by selling before they had a plan for the business. Tr. 689–90; see also Tr. 752–53. But when Stone finally received Campbell's plan, she showed little interest. Within days of the February 2 meeting, she joined the other directors in authorizing Campbell to negotiate a sale to SDL at $60 million. With the prospect of a deal that would return most or all of Hg's liquidation preference, she focused on that alternative. See Tr. 754 (Stone agreeing that “no one ever took Mr. Campbell's plan a step further from February 2nd”); see also Tr. 722–23, 750–52.

Based on this evidence and other materials on which the plaintiff relied, the plaintiff carried his burden to show that Gandhi, Scanlan, and Stone were not independent with respect to the Merger. They wanted to exit, consistent with the interests of the VC firms they represented.

c. The Outside Directors: Laidig And Prang

Two of the directors—Laidig and Prang—were neither members of management nor dual fiduciaries. The plaintiff did not challenge Laidig's disinterestedness and independence. By contrast, the plaintiff contended that (i) Prang was not independent because of his close business relationship with Gandhi and Sequoia, and (ii) he was not disinterested because he beneficially owned preferred stock through Mentor, his investment vehicle, and received a liquidation preference for his shares.

Because of the web of interrelationships that characterizes the Silicon Valley startup community, scholars have argued that “so-called ‘independent directors' ” on VC-backed startup boards “are often not truly independent of the VCs.” Agency Costs, supra, at 988. “Many of these directors are chosen by the VCs, who tend to have much larger professional networks than the entrepreneurs or other common shareholders.” Id. If there is a “conflict of interest” between the VCs and common stockholders, the “independent directors” have incentives to side with the VCs. Id. at 989.

Many of these outside directors have—or can expect to have—long-term professional and business ties with the VCs, who are more likely to be repeat players than are most of the common shareholders. Cooperative outside directors can expect to be recommended for other board seats or even invited to join the VC fund as a “venture partner.”
Id.; accord id. at 989 n. 63 (noting that “conversations with local VCs confirm” that “independent directors” have incentives to side with VCs); Exit Structure, supra, at 320 (“[I]n the event of conflict between the venture capitalist and the entrepreneur, such outside directors may have a natural inclination to side with the venture capitalist.”); Downside, supra, at 921 (arguing outside directors are “highly susceptible to the influence of the VC”). At trial, the plaintiff could not rely on general characterizations of the VC ecosystem. The plaintiff had to prove by a preponderance of evidence that Prang was not disinterested or independent in this case. The plaintiff carried his burden.

Prang had a long history with Sequoia, dating back to Sequoia's investment in Aspect Development, where Prang was President and COO. Tr. 354, 448. After Aspect Development, Sequoia asked Prang to work with them on other companies, and Gandhi recalled “a number where we worked very collaboratively ....” Tr. 354. One was Uniscape. The relationship led to Prang investing about $300,000 in three Sequoia funds, including Sequoia X, which owned Trados preferred stock. At the time of the Merger, Prang was also the CEO of Conformia Software, a company backed by Sequoia where Gandhi served on the board. When Sequoia obtained the right to designate two members of Trados's Board, Sequoia designated Gandhi and Prang. JX 79 at 14. Having considered these facts as a whole and evaluated Prang's demeanor, I find that Prang's current and past relationships with Gandhi and Sequoia resulted in a sense of “owingness” that compromised his independence for purposes of determining the applicable standard of review.

The plaintiff also introduced sufficient evidence at trial to establish that the $220,633 that Prang received in the Merger (through Mentor) was material to him. As with Campbell and Hummel, defense counsel limited inquiry into Prang's economic circumstances, asserting that “we don't think this is relevant and it makes the [witness] extremely uncomfortable.” Prang Dep. 170. Prang would only estimate that the range of his net worth at the time of the Merger was $4–6 million dollars. His sole sources of income were whatever he made from Mentor and his annual salary of $125,000 as CEO of Conformia Software. See Prang Dep. 171; Tr. 909. Given this record and the litigation position taken by the defendants, the plaintiff established that $220,633 in Merger proceeds, representing nearly double Prang's annual salary and 3.7%–5.5% of his estimated net worth, was material to Prang. Prang therefore cannot be counted as disinterested for purposes of determining the applicable standard of review.

3. Entire Fairness

A reviewing court deploys the entire fairness test to determine whether the members of a conflicted board of directors complied with their fiduciary duties. “A determination that a transaction must be subjected to an entire fairness analysis is not an implication of liability.” Emerald P'rs, 787 A.2d at 93. Conditions precedent to imposing liability include (i) a finding that the directors acted in a manner that was not entirely fair, (ii) a specification of the fiduciary duty breached (loyalty or care), and (iii) the rejection of any affirmative defenses raised by the directors, such as reliance on advisors under Section 141(e) or exculpation under Section 102(b)(7). See id. at 96–97.

“The concept of fairness has two basic aspects: fair dealing and fair price.” Weinberger, 457 A.2d at 711. Fair dealing “embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.” Id. Fair price “relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock.” Id. Although the two aspects may be examined separately, “the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.” Id. But “perfection is not possible, or expected ....” Id. at 709 n. 7.

a. Fair Dealing

The evidence pertinent to fair dealing weighed decidedly in favor of the plaintiff. Indeed, there was no contemporaneous evidence suggesting that the directors set out to deal with the common stockholders in a procedurally fair manner. Nor were the defendants able to recharacterize their actions retrospectively to show that they somehow blundered unconsciously into procedural fairness, notwithstanding their vigorous and coordinated efforts at trial to achieve this elusive goal.

i. Transaction Initiation

Fair dealing encompasses an evaluation of how the transaction was initiated. In this case, the VC directors pursued the Merger because Trados did not offer sufficient risk-adjusted upside to warrant either the continuing investment of their time and energy or their funds' ongoing exposure to the possibility of capital loss. An exit addressed these risks by enabling the VCs to devote personal resources to other, more promising investments and by returning their funds' invested capital plus a modest return. The VC directors did not make this decision after evaluating Trados from the perspective of the common stockholders, but rather as holders of preferred stock with contractual cash flow rights that diverged materially from those of the common stock and who sought to generate returns consistent with their VC funds' business model.

Gandhi started setting the table for a sale at the beginning of 2004 when he reached out to JMP and asked McClelland to speak with Ganesan. After the Board fired Ganesan in April 2004, the VC directors explored a near-term sale. They appointed Hummel as Acting President and sent him to float the idea with Trados's strongest strategic relationships, while simultaneously keeping him on a short operational leash that required clearing any material decisions with Gandhi and Scanlan. Gandhi put JMP to work canvassing other potential acquirers and fielded an inbound call from SDL, while Scanlan looked for a CEO who could fix up the Company and lead a sale process. The fact that the directors chose to hire Campbell rather than taking SDL's low-ball bid of $40 million in summer 2004 does not demonstrate, as the defendants claimed at trial, that they were not interested in an exit. It simply meant that the defendants recognized the likelihood of a suboptimal sale price given the temporarily distressed nature of the asset. It is difficult to get top dollar for a house with broken windows, loose trim, peeling paint, and an overgrown lawn. An owner who decides to fix up the place need not have changed her mind about what to do with the property.

In his first deposition, Campbell testified that upon joining Trados, he understood that his “mission” was to “help the company understand its future path, which in the mind[s] of the outside board members at that time was some type of either merger or acquisition event.” Campbell Dep. I 21. He further understood that the “[preferred investors] who had invested longer were more aggressive to find a path for the company [ i.e. the ‘merger or acquisition event’].” Id. Budge, the CFO, testified similarly. See Budge Dep. 117–18. It is hardly surprising that Campbell and Budge understood the mission in these terms. The Board was contemporaneously exploring a sale with JMP and authorized Scanlan to design the MIP to ensure that management would benefit from a sale even if the common did not.

To carry out his mission, Campbell recalled coming up with “three scenarios”: (i) an immediate sale before the Company ran out of cash, (ii) a 12–18 month managed sale that required at least $2–4 million in additional capital, and (iii) a stand-alone business plan requiring an indeterminate amount of investment. See Campbell Dep. II 17, 34–36; JX 235 at 18, 20. In Campbell's assessment, “[h]alf of the board felt that we should just do something now, take the first offer.” Campbell Dep. II 20. None of the VC directors wanted to invest in the Company to support a 12–18 month sale, much less a stand-alone business plan. Campbell was forced to raise venture debt because the “[VC] investors wouldn't kick another round [of investment] in to keep the lights on in December [2004].” Id. at 60. Actions speak louder than words, and the VC directors were telling Campbell they wanted out.

The contemporaneous documents overwhelmingly support this account. It also comports with how VCs who found themselves at or beyond their typical hold period naturally would regard a seemingly sideways if not stumbling portfolio company. Yet at trial, the defendants offered closely coordinated testimony that contradicted the contemporaneous documents and, in Campbell's case, his earlier deposition testimony. Campbell changed his story on the witness stand to claim his mission did not include a sale, but rather was “to grow the business, give it vision and create a strategy for the long-term.” Tr. 11. He denied feeling that any directors were aggressive in seeking an exit. Tr. 119–22. Whereas he previously saw Gandhi and Scanlan as the two directors who were most vocal and had de facto lead director roles, at trial he weakly recanted and suggested that he singled out Gandhi and Scanlan simply because of geographic proximity. Compare Campbell Dep. I 17, 25, with Tr. 113–14. But Scanlan was on the East Coast, and Prang was the other director in Silicon Valley. The other defendants similarly insisted they were not interested in selling the Company during 2004 and early 2005, wanted to build the business and hired Campbell for that purpose, and were pleasantly surprised when SDL happened to come along. See Tr. 246, 250, 257 (Scanlan); Tr. 445 (Gandhi); Tr. 486 (Laidig); Tr. 720–21 (Stone).

The defendants' trial testimony on this point was a litigation construct. The contemporaneous documentary evidence and Campbell's far more credible deposition testimony, backed up by Budge, establish that the VC directors wanted to exit. They were not interested in continuing to manage the Company to increase its value for the common. They initiated a sale process and pursued the Merger to take advantage of their special contractual rights.

ii. Transaction Negotiation And Structure

Fair dealing encompasses questions of how the transaction was negotiated and structured. To analyze these aspects of the Merger requires an understanding of the MIP.

VC-backed portfolio companies commonly adopt plans similar to the MIP to incent management to favor exits. See Carrots & Sticks, supra, at 5. Debate has raged for decades over whether similar severance arrangements at public companies advance stockholder interests. See, e.g., Henry F. Johnson, Those “Golden Parachute” Agreements: The Taxman Cuts the Ripcord, 10 Del. J. Corp. L. 45, 51 (1985). From a judicial perspective, the answer depends on the facts. Here, the structure and operation of the MIP provide evidence of unfair dealing towards the common stock.

Scanlan suggested a plan like the MIP in July 2004, and the Board authorized him to develop one. JX 200 at 4. In November 2004, the Board “authorized a Compensation Committee, consisting of Mr. Gandhi, Mr. Scanlan and Ms. Stone, to finalize the [MIP] and schedule [of recipients] ....” JX 261 at 5. In December 2004, Campbell and Budge presented the MIP to the Board, even though they and Hummel were the three biggest recipients. The entire Board, including Campbell and Hummel, unanimously approved it. JX 277. Not surprisingly, the MIP favored the interests of the conflicted fiduciaries who initiated, designed, presented, and approved it.

The MIP paid a percentage of the total consideration achieved in any sale to senior management, before any amounts went to the preferred or the common. The percentage payout increased as the value of the deal increased as follows: