In Re Digex, Inc. Shareholders Litigation

OPINION

TABLE OF CONTENTS

I. FACTUAL & PROCEDURAL HISTORY.1181

A. Intermedia investigates strategic alternatives. .1181

B. Digex appoints a Special Committee. .1183

C. WorldCom enters the fray. .1184

D. The deal changes. .1184

E. The Special Committee’s morning caucuses .. .1185

F. The Intermedia hoard meeting. .1186

The Digex hoard meeting. .1186

Procedural History.1187

II. STANDARD FOR A PRELIMINARY INJUNCTION .1187

1188 III. THE CORPORATE OPPORTUNITY CLAIM.

1188 A. Summary of the Arguments.

1189 B. Legal Analysis .

1189 1. Why Digex had no “interest or expectancy” in a WorldCom-Digex deal.

1192 2. Did defendants breach their duty of loyalty in negotiating the World-Com-Intermedia deal? .

8. Are the defendants estopped from completing a WorldCom-Interme-dia deal?. ^ 05 t — 1 7 — 1

4. Is this a Revlon ease?. lO 05 t — t 7 — t

IV. SECTION 208 CLAIM. Oi i-H 7 — 1

A. Does the 85% exemption apply to WorldCom? . 05 7 — I 7 — i

B. Is this Claim CJ 7 — 1

C. Was the § 203 Waiver Entirely Fair to the Digex Shareholders? O C'J 7 — (

1. Fair Dealing. C* C'J 7 — t

2. Fair Price. t — 1 C'J 7 — 1

V. THREAT OF IRREPARABLE HARM AND BALANCING OF THE POTENTIAL HARM.1214

VI. CONCLUSION.1216

This is my decision on plaintiffs’ motion to preliminarily enjoin the proposed merger between defendants WorldCom, Inc. (“WorldCom”) and Intermedia Communications, Inc. (“Intermedia”), the controlling shareholder of Digex, Inc. (“Digex”). 1 *1180 Plaintiffs, minority shareholders of Digex, seek either of two alternative forms of relief: (1) an order enjoining the defendants from consummating the Agreement and Plan of Merger dated September 1, 2000, (the “merger”), or (2) an order enjoining the Digex board’s waiver of 8 Del. C. § 203. Intermedia’s shareholders are tentatively scheduled to vote on the proposed merger on December 18, 2000.

The allegations in plaintiffs’ consolidated complaint are founded on two distinct legal theories. Plaintiffs’ first theory is that defendants usurped a corporate opportunity that (allegedly) fairly belonged to Digex by preventing Digex’s sale to the highest bidder. Plaintiffs’ second theory is that the Digex board, more specifically the four interested Digex directors, breached a fiduciary duty when they voted to waive the protections afforded Digex by § 203 of the Delaware General Corporate Law (“DGCL”).

At the outset it is important to recognize the highly unusual circumstances surrounding the pending request for injunc-tive relief. The plaintiffs have asked, in the context of a preliminary injunction, for relief that is both prospective and retrospective. Specifically, the plaintiffs seek either a preliminary injunction against the future consummation of a merger (via a claim of usurpation of corporate opportunity) or, alternatively, a preliminary decision that declares invalid or ineffective a past act of the Digex board to waive the protections afforded under 8 Del. C. § 203.

For the reasons discussed more fully below, the plaintiffs have not persuaded me that they have a likelihood of success on the merits of their corporate opportunity claim. On the other hand, they have shown a likelihood of success on the merits of their § 203 claim. In the course of analyzing the merits of the § 203 claim, however, it becomes abundantly clear that no injunctive order is necessary to protect plaintiffs from a future act or decision that threatens immediate irreparable harm. That is because the § 203 claim is based on a past decision or action from which the harm has already occurred. Any injury based on the § 203 claim has resulted not from pending action, but from action past — by the faithless acts of the four In-termedia directors who voted to waive § 203’s protections. There is no prospective harm that could be avoided by the application of a preliminary injunction. Thus, any relief must be remedial, rather than injunctive. The Court’s determination that plaintiffs have a likelihood of success on their § 203 claim means that the parties to the merger — Intermedia and WorldCom — must decide whether to proceed with that transaction knowing that this Court has preliminarily determined that Digex’s § 203 waiver will not likely be effective in the circumstances of this case. For this reason as well, no basis exists for injunctive relief based on the § 203 claim, because the plaintiffs’ ultimate success on the merits of that claim will have the practical effect of restoring to the Digex minority shareholders the protection to which they were entitled under § 203.

Notwithstanding the unusual posture in which the request for injunctive relief is presented to the Court, I will address the application in the typical fashion of a motion for a preliminary injunction. In Part I of this Opinion I set forth the factual and procedural history relevant to the resolution of plaintiffs’ motion. Part II describes the applicable standard for preliminary injunctive relief. In Part III, I address plaintiffs’ corporate opportunity *1181 claim, while Part IV considers plaintiffs’ alternative § 203 claim. Part V considers the irreparable harm and balance of the equity prongs of the preliminary injunction standard. Finally, Part VI sets forth my conclusions.

I. FACTUAL AND PROCEDURAL HISTORY 2

A Intermedia investigates strategic alternatives

Intermedia and Digex are both Delaware corporations. Intermedia is an integrated communications provider delivering local, long distance, and enhanced data services, principally to business and governments. Digex provides managed web hosting and application hosting services primarily to large corporate clients. In-termedia has held a controlling interest in Digex since July 1997. Following public offerings in August 1999 and February 2000, Intermedia now owns 52% of Digex’s outstanding stock which represents approximately 94% of the voting power of all of Digex’s outstanding stock. 3

During the time periods relevant to this case, Digex’s board of directors had eight members, five of which — David C. Ruberg, Robert M. Manning, Philip A. Campbell, John C. Baker, and George F. Knapp— were also officers or directors of Interme-dia. 4 The interested directors stood to personally profit tremendously upon a sale of Intermedia, but to profit very little, or not at all, upon a sale of Digex. 5 The remaining three directors — Jack E. Reich, Richard A. Jalkut, and Mark K. Shull— were not affiliated with Intermedia.

Digex is well positioned in one of the hottest segments of the technology sector — web hosting. Intermedia, however, is in poor financial condition. 6 Since early 1999, Intermedia has been considering strategic options to maximize the value of both itself and Digex, including the possible sale of itself or its various holdings. This effort continued in earnest in June 2000, following the NASDAQ downturn. At this time, it was apparent to Intermedia that it would be difficult to arrange financing to fund Digex and Intermedia on a long-term basis, a prospect that threat *1182 ened the survival of both corporations. Thus, on June 29, Intermedia hired Bear Stearns & Co. (“Bear Stearns”) to explore all possible strategic alternatives. 7 On this same day, Intermedia informed the Digex board that it planned to explore the feasibility of a sale of its equity interest in Digex. On July 11, Intermedia issued a press release announcing that they had retained Bear Stearns to explore Interme-dia’s strategic alternatives with regard to Digex, including the possible sale of In-termedia’s ownership position in Digex to another company.

In July, Bear Steams approached WorldCom about potential strategic alternatives concerning Intermedia and Digex. A deal involving Intermedia presented an opportunity for WorldCom on two fronts. First, Intermedia has a presence in the Competitive Local Exchange Carrier (CLEC) market and WorldCom could acquire these CLEC assets. Second, through Digex, WorldCom could expand its presence in the critical web-hosting arena.

WorldCom was not the only potential suitor for Intermedia approached by Bear Stearns. During July and August, Bear Stearns contacted thirty likely suitors for Intermedia or Digex, received expressions of interest from thirteen, sent confidentiality agreements to ten, and received executed non-disclosure agreements from, and sent materials to, six. 8 Ultimately, three suitors emerged: Exodus Communications Inc. (“Exodus”), Global Crossing, Ltd. (“Global Crossing”), and WorldCom.

Though Global Crossing was involved up until the end, 9 WorldCom would prove to be the successful suitor. 10 As early as July 17, a junior member of WorldCom’s corporate development team prepared a presentation analyzing four possible alternative transactions among WorldCom, Digex, and Intermedia. On or about August 2, the corporate development department put together a formal presentation package concerning opportunities in the web hosting field, including a detailed discussion of In-termedia and Digex — together and individually — as potential acquisition targets for WorldCom. During this same period, WorldCom was also negotiating a possible joint venture in the web hosting arena with Global Crossing, but these talks ended when WorldCom discovered that Global Crossing had simultaneously been negotiating a three-way merger with Intermedia and Digex. By the end of August, World-Com had focused on Intermedia and Digex.

*1183 B. Digex appoints a Special Committee

The directors of Intermedia and Digex understood from the beginning of this process undertaken by Bear Stearns that conflicts of interest might arise between the two companies. Put simply, Digex was a rapidly growing company that was extremely attractive to potential suitors. As stated above, Intermedia had severe financial problems. In fact, as of August, Intermedia’s equity holdings in Digex exceeded Intermedia’s total market capitalization. Intermedia and its banker, Bear Stearns, had three possible avenues before it. Intermedia could sell itself, could sell its holdings in Digex, or could sell part or all of both companies.

If Intermedia sold itself (which, of course, would include its majority stake in Digex), Intermedia’s shareholders stood in a position to reap a substantial premium on their shares, largely due to the acquirer’s presumable desire to obtain control over Intermedia’s “crown jewel,” Digex. This was especially true with regard to Intermedia’s officers and directors, who, as discussed above, stood to profit tremendously from a sale of Intermedia. In contrast, Digex’s shareholders stood to gain comparatively little under this possibility, at least in the short term, other than a new controlling shareholder.

If Intermedia sold part or all of its Digex holdings, Intermedia could expect a significant payoff to fund its own operations, but Intermedia’s shareholders, and especially its officers and directors, would not personally benefit to the extent they would if Intermedia itself were sold. Under this possibility, Digex shareholders could expect to reap a significant premium if Intermedia sold its holdings to an acquirer who decided to then tender for all outstanding Digex shares.

These various options and possibilities clearly presented the potential for conflicts of interest for the interested Digex directors, both due to their dual directorships and their direct, personal financial interests in any potential transaction. Thus, on July 26, 2000, the Digex board of directors appointed a special committee (the “Special Committee”) comprised of two of the three independent Digex directors — Jalkut and Reich. Their role was “to participate in the transaction process and make recommendations to the full board of directors on matters where there could be a perceived conflict of interest between Intermedia and Digex.” 11 The Special Committee had its own legal counsel, James Clark of Cahill Gordon & Rein-del (“Cahill”), and its own financial advis-ors, Credit Suisse First Boston (“CSFB”). The Special Committee appeared to have authority. In the end, however, the Special Committee could not stop Intermedia’s decision to sign an agreement on September 1 to merge with WorldCom, even though the Committee believed other potential transactions were better for Digex.

The true extent of the Special Committee’s authority was evident as early as August, before WorldCom came on the scene. The Special Committee was involved primarily with the Exodus transaction during July and August. On August 21 the Special Committee arrived at the Digex board meeting prepared to vote on an Exodus transaction, but learned when it arrived that such a transaction would not be presented for a vote. 12 Instead, the Special Committee learned that negotiations were underway with Global Crossing.

*1184 C. WorldCom enters the fray

Although WorldCom had conducted internal evaluations regarding a possible transaction with either Intermedia or Digex as early as July, these evaluations did not result in any action until August 30. On that day, WorldCom began to seriously consider a bid for control of Digex. Almost exactly forty-eight hours would elapse between WorldCom’s first contact, a call from its banker to Bear Stearns late on August 30, and the Intermedia board’s approval of the WorldCom-Intermedia merger late in the afternoon on September 1.

Those forty-eight hours began on August 30 between 6:00 and 7:00 p.m. when Scott Miller of Salomon Smith Barney & Co. (“Salomon”), WorldCom’s bankers, called Andrew Decker of Bear Stearns with an expression of interest to acquire Digex at $120 a share or more. Miller told Decker that WorldCom would outbid anyone for Digex. After speaking with In-termedia’s negotiators, Decker informed Miller that WorldCom would have to move quickly. WorldCom did just that. Through various phone calls that evening, WorldCom decided to send a due diligence team to New York the following day in order to negotiate a transaction. Sutcliffe sent a draft merger agreement, which was only for a direct acquisition of Digex, to WorldCom’s counsel, Cravath, Swaine & Moore (“Cravath”). 13 Late in the evening of August 30, around 11:00 p.m., Ruberg telephoned each of the Special Committee members and informed them that World-Com had offered $120 per share for Digex.

Global Crossing still had an outstanding offer at this point and was working toward a September 1 signing. On the morning of August 31, Sutcliffe and Decker told Global Crossing that there was another suitor for Digex — WorldCom. Global Crossing decided not to bid against WorldCom but continued working toward its September 1 target.

The WorldCom due diligence team arrived at Sutcliffe’s office in New York on August 31, sometime shortly after noon. There, they met with various senior executives from Digex and discussed numerous operational issues regarding Digex. At one point, William Grothe, Vice President of Corporate Development for WorldCom, Sutcliffe, Ruberg, Decker, and another Bear Stearns representative met separately to discuss Intermedia’s concern that the transaction was not moving quickly enough. These men testified that both before and during this private meeting, the only deal that was being discussed was WorldCom’s direct acquisition of Digex. 14

D. The deal changes

After this private meeting, Bernard Eb-bers, WorldCom’s President, and Grothe had several phone conversations. Grothe testified that at about 5:00 p.m. on August 31, Ebbers told him that WorldCom was going to purchase all of Intermedia rather than Digex. 15 In the late afternoon of August 31, Ebbers called and left a message for Decker, who returned the call at about 6:00 p.m. A series of calls ensued. First, Decker spoke with Ebbers and Scott Sullivan, WorldCom’s CFO. During this call, Ebbers asked Decker if it were possi *1185 ble for WorldCom to leave Digex outstanding as a public company and buy Interme-dia. 16 Decker consulted with Intermedia and then called Ebbers to inform him that Intermedia would entertain an offer at $89 a share in WorldCom stock. Ebbers conditionally approved an acquisition of In-termedia at $39 a share in WorldCom stock. 17 Sutcliffe notified Clark, legal counsel to the Special Committee, of the change, and Clark informed the Special Committee. Ruberg informed Shull, Digex’s President and CEO, and Timothy Adams, Digex’s CFO. Clark and Sutcliffe had several phone conversations that evening regarding the Special Committee’s “belief or fear” that Intermedia had manipulated WorldCom’s interest from Digex to Intermedia. 18 Sutcliffe denies such manipulation. 19

During the night and morning of August 31-September 1, Intermedia and World-Com negotiated the merger and World-Com conducted abbreviated due diligence of Intermedia. Sutcliffe suggested that WorldCom should make a tender offer for the Digex public shares, but WorldCom refused. 20 Also during these negotiations, WorldCom first expressed its interest in receiving the waiver of § 203 from the Digex board. Intermedia agreed to seek this waiver, but requested, and received in return, an agreement to amend the Digex certifícate of incorporation to require independent director approval of any material transaction between WorldCom or its affiliates. 21 On September 1, Sutcliffe asked Grothe to be sure to address the Special Committee’s possible fear that Intermedia had caused WorldCom to shift its interest from Digex to Intermedia. 22

E. The Special Committee’s morning caucuses

Up until this point, the Special Committee had not been intimately involved with the proposed WorldCom-Digex transaction. Until the late evening of August 31, the Special Committee had been led to believe WorldCom was buying Digex. Now, the Committee members knew the deal had changed and, once again, it had changed without their consultation. This had happened just the morning before at the August 31 Digex board meeting, when the Special Committee members were informed, much to their surprise, that the Global Crossing-Digex transaction had been changed to a WorldCom-Digex transaction.

Thus, on the morning of September 1, the Special Committee, Jalkut and Reich, met with their lawyer, Clark, and Shull and Adams, for a breakfast meeting around 7:00 a.m. to discuss their options. Specifically, they asked Clark for his legal opinion regarding the validity of the switch to the WorldCom-Intermedia merger that was currently being negotiated from the *1186 Digex sale they preferred. Clark responded that they could not force WorldCom to make a bid for Digex itself. 23 Clark also stated that he believed that legal opinion was divided on the applicability of § 208. 24 Clark had concerns both about the process, especially the circumstances surrounding the mid-stream switch from a Digex to an Intermedia deal, and about whether the Special Committee had been kept fully informed. 25

Shull, Jalkut, and Reich devised a strategy of proposing a mini-auction at the Digex board meeting later that day because they all believed the proposed WorldCom-Intermedia transaction was the worst of the three possible deals for Digex. 26 Shull admits, however, that he saw some concrete benefits to Digex of a WorldCom-Intermedia merger, including the availability of WorldCom’s global network and facilities. 27

Next, the Special Committee met with Ruberg who reported the sequence of events culminating in WorldCom’s offer for Intermedia. According to Jalkut, Ru-berg assured the Special Committee that the deal was in the best interests of both Intermedia and Digex. 28 No mention was made during this meeting of the § 203 waiver issue.

Finally, the Special Committee met with its financial advisors, CSFB, in order to prepare for the Digex board meeting later that day. During the time when the Special Committee was meeting with their financial advisors at CSFB’s New York offices, Ebbers of WorldCom had a 45-minute telephone conversation with Jalkut and Reich, as Clark had requested. 29 Ebbers explained the reasons why WorldCom had changed the deal. Ebbers also explained that WorldCom intended to keep Digex public. Grothe spoke to Shull and Adams in a separate call, also arranged by Clark. Grothe reiterated WorldCom’s intention to keep Digex public. Around 1 p.m. Jalkut and Reich left CSFB’s offices to go to Bear Stearns, where the Intermedia meeting was in progress. Immediately following the Intermedia meeting, the Digex board met. 30

F. The Intermedia board meeting

The Intermedia board also met on the morning of September 1 to discuss the proposed WorldCom transaction. Following their discussion of the need for a § 203 waiver by Digex, the Intermedia board meeting was adjourned and Reich, Jalkut, and Shull, as well as the Special Committee’s advisors, were invited into the room for a meeting of the full Digex board. The interested directors of Digex, who had been in the room for the Intermedia meeting, remained, as did Bear Stearns, for the Digex meeting.

G. The Digex board meeting

Sutcliffe informed the Digex board that Intermedia had considered the WorldCom and Global Crossing proposals and determined that the WorldCom proposal was better for Intermedia. CSFB presented its findings to the entire board. CSFB concluded that the WorldCom deal was the *1187 worst for Digex. 31 None of the directors asked any questions regarding CSFB’s conclusions.

As had been planned at the breakfast meeting, Jalkut proposed a mini-auction of Digex, ie., that a decision on the World-Com transaction be deferred for approximately three days to allow CSFB to solicit best and final offers from WorldCom, Exodus, and Global Crossing, as well as to determine whether any other potential bidders existed. After some discussion, the proposal was defeated by a vote of four to three. The three disinterested directors voted in favor of the auction and the four interested directors voted against any step that would delay the WorldCom transaction.

The Digex board then turned its attention to the § 203 waiver. The debate, however, was brief and truncated, with discussion limited to the issue of who should vote on the waiver. Clark argued that due to the clear conflicts of interest faced by the interested directors, they should abstain from the vote. Sutcliffe asserted that he saw no reason to prevent the interested directors from participating. Sutcliffe would later testify that, “I discussed with [the interested directors] or reminded them that in voting on anything as a Digex director, they had to disregard entirely their relationship with Intermedia and had a fiduciary obligation to act only in the best interest of Digex and all of its shareholders.” 32 The Special Committee was never asked for a recommendation on this conflict. After some discussion regarding whether or not the interested directors should vote, it was decided that all board members should vote. As noted above, it appears from the record that Clark and Sutcliffe disagreed about whether it was appropriate for the interested Digex directors to vote on the § 208 waiver. It is far less clear whether the Digex directors themselves engaged in any discussions along these lines. 33 The vote, once again, was four to three, with only the interested directors — Ruberg, Manning, Campbell, and Baker — voting in favor of the § 203 waiver. After the Digex board members voted on the § 203 waiver, the Intermedia board reconvened, received Bear Stearns’ oral fairness opinion, and approved the Intermedia merger with WorldCom.

H. Procedural History

Following the public announcement on September 5, 2000, of the proposed merger between Intermedia and WorldCom, Digex stockholders filed a series of class and derivative stockholder suits. Ultimately, all of the actions were consolidated into this single action and WorldCom was joined as a party defendant. On October 2, 2000, this Court granted plaintiffs’ motion for expedited proceedings. Thereafter, the parties engaged in expedited discovery, including the production of documents, numerous depositions, and the filing of legal memoranda. Plaintiffs’ motion for a preliminary injunction was argued before the Court on November 29. At the Court’s request, the parties filed supplemental memoranda regarding the § 203 issue on December 4.

II. STANDARD FOR A PRELIMINARY INJUNCTION

This matter is presently before the Court on plaintiffs’ motion for a preliminary injunction. When seeking a *1188 preliminary injunction, a plaintiff must demonstrate a reasonable probability of success on the merits and that some irreparable harm will occur in the absence of the injunction. Furthermore, in evaluating the need for a preliminary injunction, the Court must balance the plaintiffs need for protection against any harm that can reasonably be expected to befall the defendants if the injunction is granted. When the former outweighs the latter, then the injunction should issue. 34

As I noted earlier, the plaintiffs assert two different legal theories in this action. First, they argue that the defendants have breached their fiduciary duties and usurped a corporate opportunity that belonged to Digex and its shareholders. Second, the plaintiffs contend that the defendants breached the fiduciary duties they owed to Digex and its shareholders by voting to waive the protections afforded by § 208. I turn first to the corporate opportunity theory.

III. THE CORPORATE OPPORTUNITY CLAIM

Delaware Courts employ the following test to determine whether a corporate opportunity has been usurped by a fiduciary. The corporate opportunity will be found to have been usurped:

If there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake, [and that opportunity] is ... in the line of the corporation’s business and is of practical advantage to it, is one in which the corporation has an interest or a reasonable expectancy, and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation .... 35

It is with this test in mind that I will evaluate the plaintiffs’ claim that the defendants have usurped a corporate opportunity belonging to Digex.

A. Summary of the Arguments

The plaintiffs argue that they satisfy all elements of the test for the usurpation of a corporate opportunity and, thus, there is a likelihood that they will succeed on the merits at trial. The opportunity that plaintiffs insist they had was an “expectancy” in selling their Digex shares to a buyer for approximately $120.00 per share.

That expectancy, the plaintiffs urge, was created by Intermedia’s alleged promise that any deal Intermedia brokered would include a sale of the Digex minority shareholders’ shares. As the argument goes, the defendants breached their fiduciary duties when the Intermedia-affiliated Digex directors allegedly steered WorldCom away from a Digex deal and towards an Intermedia deal. 36 When a WorldCom-Intermedia deal originally arose, plaintiffs argue that the interested directors had several courses of action available that would have avoided such a breach. For instance, “they could have refused to discuss with WorldCom anything other than *1189 an acquisition of Digex, or they could have conditioned any acquisition of Intermedia on WorldCom’s agreement to make a tender offer for the minority shares of Digex.” 37 The import of this, urge plaintiffs, is that “when WorldCom asked Intermedia for a price at which WorldCom could acquire Intermedia, Intermedia was not permitted to name its price and make an agreement with WorldCom without informing Digex’s Special Committee and affording it an opportunity to negotiate with WorldCom on behalf of Digex.” 38

The defendants respond to these contentions with three primary arguments. First, they argue that there was no corporate opportunity to usurp because “In-termedia owns an absolute majority of Digex’s voting rights and equity. Intermedia is entitled to sell or refuse to sell its Digex stock solely in its own interest; it is entitled to vote its shares in its own interest; and, neither the Digex board nor its shareholders can sell Digex without Interme-dia’s consent.” 39 The second argument the defendants make is that they acted properly and mindful of their fiduciary duties at all relevant times. Thus, because the defendants were entirely candid with the Digex board and because WorldCom approached Intermedia as the controlling shareholder rather than Digex itself, there can be no breach of the duty of loyalty. Finally, and tangentially related to the first argument, defendants contend that the Digex minority shareholders had no power to insist that Intermedia, as controlling shareholder, permit Digex to conduct an “auction” to sell itself to the highest bidder.

B. Legal Analysis

For the reasons discussed below, I conclude that Digex, as a corporation, had no legally cognizable “interest or expectancy” in a WorldCom-Digex deal. Thus, the plaintiffs will not be able to prove an element of the corporate opportunity doctrine and are unlikely to succeed on the merits. Moreover, while the behavior of certain actors in this corporate drama does not paint a picture of model director behavior, I cannot conclude, on the limited factual record before me, that the defendants’ conduct was undertaken in bad faith. Because I am deeply skeptical that the plaintiffs will be able to produce evidence at trial to prove their currently unsupported suspicions, I am not persuaded that plaintiffs have a reasonable probability of success on the merits of their corporate opportunity claim.

1. Why Digex had no “interest or expectancy” in a WorldCom-Digex deal.

A claim that a director or officer improperly usurped a corporate opportunity belonging to the corporation is a derivative claim. 40 Here, it is helpful to distinguish between a derivative and an individual claim.

As a general matter, it may be said that, where the substantive nature of the alleged injury is such that it falls directly on the corporation as a whole and collectively, but only secondarily, upon its stockholders as a function of and in proportion to their pro rata investment in the corporation, the claim is derivative in nature and may be maintained only on behalf of the corporation... .Conversely, where the complaint describes a *1190 special and distinct injury inflicted directly on rights of individual stockholders traditionally regarded as an incident of their stock ownership, the action is individual (or class) in nature, and any ensuing recovery or other relief runs directly to the stockholders. In other words, derivative actions are those that seek relief for injuries done to the corporation, while individual or class claims are those that seek to rectify harm inflicted directly upon the individual rights of stockholders. 41

With this distinction in mind, the claim that the defendants usurped a corporate opportunity must necessarily constitute an “injury” to the corporation and thus be a derivative claim. 42

Here, the plaintiffs contend that the defendants, by allegedly steering WorldCom away from a Digex deal and towards an Intermedia deal, appropriated an opportunity that belonged to the plaintiffs. That opportunity was the ability to sell Digex to the highest bidder.

The opportunity the plaintiffs identify, however, is not an “interest or expectancy” of Digex the corporation qua corporation. Rather, the purported opportunity is that of the Digex shareholders to sell their Digex shares to the highest bidder. Thus, the perceived corporate opportunity is not really a corporate opportunity at all, but more closely resembles an individual opportunity of the shareholders. Because the opportunity the plaintiffs identify was not one in which Digex as a corporation had an “interest or expectancy,” plaintiffs do not have a reasonable likelihood of success on such a claim.

The present case also is strikingly similar to Thorpe v. CERBCO, Inc., 43 a case cited by both parties as supporting their respective positions. In CERBCO, the Supreme Court held that where a majority shareholder of a corporation can block any unacceptable transaction, the corporation cannot take advantage of the opportunity to enter into an unsanctioned transaction and, thus, there is no opportunity that fairly belongs to the corporation. 44

George and Robert Erikson were directors, officers, and controlling shareholders of CERBCO, Inc. While the Eriksons owned 24% of CERBCO’s total equity, they exercised effective voting control with 56% of the total votes. They were also two of the four directors on CERBCO’s Board.

CERBCO, as a holding company, owned voting control of a subsidiary, Insituform East, Inc. (“East”). A third party approached the Eriksons in their capacity as directors and officers 45 of CERBCO to discuss the possible purchase of the subsidiary East. The Eriksons, however, steered the third-party towards buying their controlling interest in the parent CERBCO as a way to gain control of the subsidiary East. Thorpe, a CERBCO shareholder, filed a derivative suit claiming that the Eriksons had diverted from CERBCO the opportunity to sell East to the third-party. Thus, as is quite plain, in many respects the facts of CERBCO are similar to those here. 46

*1191 The Court of Chancery, following a trial, found that the Eriksons violated their duty of loyalty to CERBCO. “Despite finding this breach,” however, “the Chancellor held that the plaintiffs would not be awarded damages since the defendants’ actions were wholly fair.” 47 The Chancellor found that the Eriksons could not be penalized for their breach because they could veto any proposed transaction under 8 Del. C. § 271 48 and, thus, the plaintiff suffered no damage.

The Supreme Court, in addressing the issue of the corporate opportunity, found that:

In this case, it is clear that the opportunity was one in which the corporation had an interest. Despite this fact, CERBCO would never be able to undertake the opportunity to sell its EAST shares. Every economically viable CERBCO sale of stock could have been blocked by the Eriksons under § 271. Since the corporation was not able to take advantage of the opportunity, the transaction was not one which, considering all the relevant facts, fairly belonged to the corporation. 49

The Court went on to find that the “ § 271 rights, not the breach [of the duty of loyalty], were the proximate cause of the nonconsummation of the transaction. Accordingly, transactional damages are inappropriate.” 50

I understand the Supreme Court’s holding in CERBCO to require a finding that, while majority shareholders may breach their duty of loyalty on similar facts, the powers inherent in the majority status generally preclude a plaintiff from claiming that a corporate opportunity has been usurped where the majority shareholder could have blocked the transaction in any event. This is so because no “interest or expectation” fairly belonged to the corporation since the majority could block the transaction at any time.

The same reasoning leads to the same result in this case. Just as the Eriksons could block CERBCO’s efforts to sell the subsidiary East, so Intermedia may block any undesirable transactions involving its subsidiary Digex. 51 Of course, CERBCO teaches that this power, held by the controlling shareholder, is not without limit. As is discussed more fully below, the exercise of that power is always constrained by the duty of loyalty.

In some respects this case is clearer than CERBCO because here the complaining parties, Digex and its shareholders, are totally removed from the transaction between WorldCom and Intermedia. No Digex shares will change hands and, presumably, Digex’s preexisting relationship with Intermedia will be the same. Intermedia would merely have a new owner.

Because the defendants could block proposed transactions involving the sale of Digex, it seems unlikely that Digex and its shareholders could have a legally cognizable interest or expectancy in a WorldCom-Digex deal. In the absence of such a protectable interest, plaintiffs have no rea *1192 sonable probability of success on the merits of their corporate opportunity claim.

2. Did defendants breach their duty of loyalty in negotiating the WorldCom-Intermedia deal?

In the context of the corporate opportunity claim, plaintiffs appear to rely upon two distinct theories as to how the defendants breached their fiduciary duties. First, they contend defendants breached the duty of loyalty by usurping a corporate opportunity, a claim which (as already mentioned) stands little chance of success. Second, they argue that the recent decision in McMullin v. Beran 52 requires a finding that the defendants breached their fiduciary duties by not conducting “a Revlon auction for Digex.”

As to this second theory, Thorpe v. CERBCO again is instructive. There the Supreme Court separated the consideration of whether the defendants usurped a corporate opportunity and whether they breached their duty of loyalty. Since I have already addressed the corporate opportunity aspect of the argument, I now turn to the duty of loyalty aspect.

The CERBCO Court found the Eriksons had breached their duty of loyalty to CERBCO. How the CERBCO Court reached that conclusion will guide this Court in determining whether the defendants have breached a duty of loyalty owed to the plaintiffs.

In CERBCO, the third party approached the Eriksons, in their capacity as officers and directors, about the potential purchase of the subsidiary, East. The Eriksons, however, immediately steered the third-party towards purchasing their controlling block of CERBCO in order to gain control of East. 53

The Eriksons never informed the other CERBCO board members of this interest in the subsidiary East, but did inform them of the proposed sale of the Eriksons’ stock. In fact, a member of the CERBCO board later specifically asked the Eriksons whether there had been any interest in a purchase of East. “The Eriksons denied that [the third-party] had ever made such an offer, and had [they] done so, the Erik-sons indicated that they would likely vote their shares to reject it.” 54

Ultimately, it was this lack of candor that led both the Chancellor and the Supreme Court to find that the Eriksons had breached their duty of loyalty. 55 To reach this result, the Court applied the following analysis:

The shareholder vote provided by § 271 does not supercede the duty of loyalty owed by control persons, just as the statutory power to merge does not allow oppressive conduct in the effectuation of a merger. Rather, this statutorily conferred power must be exercised within the constraints of the duty of loyalty. In practice, the reconciliation of these two precepts of corporate law means that the duty of a controlling shareholder/director will vary according to the role being played by that person and the stage of the transaction at which the power is employed. 56

In applying this analytical framework, the Court decided that since the Eriksons were approached in their capacities as directors of CERBCO, their loyalties should have been to the company. To satisfy their duty to act in good faith, the Erik- *1193 sons should have informed the CERBCO board of the interest in East and CERB-CO should have been able to explore that interest “unhindered by the dominating hand of the Eriksons.” 57

The Court recognized that “[t]he Erik-sons were entitled to profit from them control premium and, to that end, compete with CERBCO but only after informing CERBCO of the opportunity. Thereafter, they should have removed themselves from the negotiations and allowed the disinterested directors to act on behalf of CERB-CO.” 58 Finally, “[w]hile the Eriksons did have a duty to present that opportunity to CERBCO, they had no responsibility to ensure that a transaction was consummated.” 59

Thus, if one compares the Eriksons’ behavior to that of the defendants here, I must consider whether the defendants adequately disclosed any potential interest or proposal to Digex and provided Digex a reasonable opportunity to act. If the defendants did not act in that manner, it may well suggest that they breached a duty of loyalty to Digex’s minority shareholders.

To answer this question, one must focus on the events that occurred between August 30, 2000, and September 1, 2000. 60 Viewing those events objectively, it appears that Digex, through its officers and non-interested directors, was apprised of the status of the various proposed transactions at all times. Despite preliminary posturing and expressions of general interest in the preceding months, the time frame at issue was compressed into a matter of a few days. The evidence indicates that WorldCom was interested in Digex and had considered various ways to gain control of it. Among