Opinion ID: 2275517
Heading Depth: 1
Heading Rank: 9

Heading: Board's Primary Purpose: Impede Effective Vote

Text: The expedited trial was held by the Court of Chancery, as scheduled. During pretrial discovery, the Director Defendants identified the primary purpose of their action in expanding the Liquid Audio board from five to seven members. Their response to the following interrogatory request is illustrative: 6. Summarize the complete reasons that support the decision of the Board to amend the Bylaws or to approve the Bylaw Amendment. Response: Subject to and without waiving the General Objections stated above, Defendants state that the Board of Directors, after receiving legal advice regarding their fiduciary duties, voted to expand the size of the board after a thorough and deliberate evaluation of the qualifications and expected contributions of Judith N. Frank and James D. Somes to Liquid's current operations and business plans. Furthermore, the Board of Directors believed that the Company would benefit from having seven directors instead of only five directors. In particular, the Company believed that it would benefit from creating new directorships and placing two additional outside directors on the board in light of the potential difficulties that may result from the addition of MM's nominees on the Board and in light of the possibility that one or more directors would decide to resign for a variety of reasons including, but not limited to, a reluctance to serve alongside a slate of directors proposed by MM .... When defendant Doig was asked to elaborate upon this response to the interrogatory request, he testified: There was concern that if the MM slate won and then it did become too acrimonious and that Ms. Winblad and Mr. Imbler decided to resign, that ran an undue risk to the shareholders by giving MM the ability to control the company. The testimony of each other member of the Board also reflects that the Director Defendants were concerned that incumbent directors Winblad and Imbler would resign from the Liquid Audio board if MM's nominees were elected to the board at the annual meeting, which would result in MM gaining control of the Board. The record also reflects that the timing of the Director Defendants' decision to expand the Board was to accomplish its primary purpose: to minimize the impact of the election of MM's nominees to the Board. The Court of Chancery's post-trial ruling from the bench states: The board's concern was that given the past acrimonious relationship between MM and Liquid Audio, a relationship characterized by litigation, if MM's two nominees were elected, the possibility of continued acrimony might cause one or more of the current board members to resign. If one director resigned, that would deadlock the board two-to-two; and if two directors resigned, then MM would gain control on a two-to-one basis. Either scenario could jeopardize the pending merger, which the incumbent board favored. That was the primary reason. (emphasis added). After making that factual determination, the Court of Chancery recognized the effect of the Board's action in changing the size and composition of its membership immediately prior to the election of directors at the annual meeting: By adding two additional directors, the board foreclosed the result that it feared: The possibility of a deadlock or of MM taking control of the board. The reason is that even if MM's two nominees were elected at the 2002 annual meeting, the current directors would still constitute a majority of five. The result of the board's action was to diminish the influence of any nominees of MM that were elected, at least in numerical terms. Thus, based upon the evidence presented at trial, including an assessment of the witnesses' credibility, the Court of Chancery concluded that the Director Defendants amended the bylaws to expand the Board from five to seven, appointed two additional members of the Board, and timed those actions for the primary purpose of diminishing the influence of MM's nominees, if they were elected at the annual meeting.