26th TULANE CORPORATE LAW
INSTITUTE:
DELAWARE DEVELOPMENTS
March 27, 2014
Justice Henry duPont Ridgely
Fredrick Alexander
Paul Choi
Brad Davey
Mark Gentile
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Delaware Developments: Overview of Topics
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Preferred Stock Issues
Standard of Review
Appraisal Rights
Forum Selection
Additional Developments
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Delaware Developments: Preferred Stock Issues
• In In re Orchard Enterprises, Inc. S’holder Litig., the Court of Chancery
held that a proxy statement in connection with a merger was
materially misleading where it misstated in two places that an
amendment to the certificate of incorporation was necessary to
prevent the allocation of merger consideration to the holders of
preferred stock to satisfy their liquidation preference where the
merger did not in fact trigger the preferred stockholders’ liquidation
preference.
• Relying on Section 242 of the DGCL which requires, in connection
with seeking stockholder approval of a charter amendment, that
stockholders receive notice setting forth such charter amendment or
a brief summary thereof, the Court stated that:
– “The DGCL does not require that stockholders receive many items
of information, but those that it does require are material per se.”
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Delaware Developments: Preferred Stock Issues
• In Lehman Brothers Holdings, Inc. v. Spanish Broadcasting System,
Inc., the Court of Chancery held that preferred stockholders had
acquiesced to a corporation’s incurrence of additional debt that was
allegedly in violation of their contractual rights where, among other
things:
– The preferred stockholders had knowledge of their rights under the certificate
of designation to appoint directors in the event of the nonpayment of dividends
for four consecutive quarters;
– Under the preferred stockholders’ purported reading of the certificate, the
holders knew or should have known that such right was triggered;
– The preferred stockholders knew that the corporation intended to enter into
debt transactions, but did nothing leaving the corporation to believe that the
preferred stockholders had acquiesced;
– The corporation’s belief was reasonable because, among other things, preferred
stockholders had a mechanism whereby they could request a special meeting to
elect the preferred directors; and
– The corporation entered into the debt transactions in reliance on the preferred
stockholders’ acquiescence.
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Delaware Developments: Preferred Stock Issues
• In In re Trados Inc. S’holder Litig., the designees of four VC funds
that held preferred stock representing a controlling interest in the
corporation constituted four of seven board members.
• Of the $60 million of total merger consideration: $52 million went
to holders of preferred stock, $8 million went to management in
newly adopted incentive plan and no consideration went to holders
of common stock.
• In its post-trial opinion, the Court of Chancery found that the
board’s decision to approve the cash-out merger was entirely fair,
notwithstanding the fact that the common stockholders received
no consideration.
• Reviewing the transaction for entire fairness, the Court found that,
although the process was not fair, the decision to approve the
merger was entirely fair because the common stock had no
economic value before the merger and its appraised value was zero.
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Delaware Developments: Preferred Stock Issues
• The Court of Chancery reasoned that the process was not fair
because the directors:
– Analyzed the transaction from the perspective of holders of
preferred stock;
– Did not consider how to fairly allocate the funds payable
pursuant to the management incentive plan among the
common and preferred stockholders;
– Did not consider how the management incentive plan skewed
the negotiation and structure of the merger in a manner
adverse to the common stockholders;
– Did not understand that their role was to maximize value for the
common stockholders; and
– Did not consider conditioning the merger on the approval of a
majority of the disinterested common stockholders.
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Delaware Developments: Standard of Review
• The applicable standard of review which will be applied by
Delaware courts to in transactions in which controlling
stockholders are involved is an evolving area of the law.
• The role of the controlling stockholder in the transaction and
the protective devices utilized in the process, if any, may
dictate the applicable standard of review.
• A nuanced factual analysis will also be employed by Delaware
courts in assessing whether protective devices, such as use of
a special committee or a majority-of-the-minority vote should
be credited.
• Three variations – (i) controlling stockholder on other side, (ii)
controlling stockholder getting different consideration and (iii)
controlling stockholder receiving the same consideration.
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Delaware Developments: Standard of Review
• In In re MFW S’holders Litig., the Delaware Supreme Court
affirmed the Court of Chancery’s grant of summary judgment in
an action challenging a merger of M&F Worldwide with its
controlling stockholder.
• The Delaware Supreme Court, stressing the “vital distinction”
between cases such as Kahn v. Lynch and its progeny (in which
“the controller did not give up its voting power by agreeing to a
non-waivable majority-of-the-minority condition”) and the facts
at issue in MFW, held that the business judgment standard of
review applies to a controlling stockholder merger when it is
conditioned, ab initio, on:
– Negotiation and approval by an independent, fully functioning and
duly empowered special committee that fulfills its duty of care; and
– The uncoerced, fully informed vote of a majority of the minority
stockholders.
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Delaware Developments: Standard of Review
• Thus, under the MFW framework, in controller buyouts, the
business judgment standard of review will be applied if and only
if:
– the controller conditions the procession of the transaction on the
approval of both a special committee and a majority of the minority
stockholders;
– the special committee is independent;
– the special committee is empowered to freely select its own
advisors and to say no definitively;
– the special committee meets its duty of care in negotiating a fair
price;
– the vote of the minority is informed; and
– there is no coercion of the minority.
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Delaware Developments: Standard of Review
• Importantly, however, the Court held that if a plaintiff can plead a
reasonably conceivable set of facts showing that any or all of the
conditions entitling the merger to the business judgment
standard of review did not exist, the complaint would state a
claim for relief that would entitle the plaintiff to proceed and
conduct discovery.
• Further, “[i]f after discovery, triable issues of fact remain about
whether either or both of the dual procedural protections were
established, or if established were effective, the case will
proceed to a trial in which the court will conduct an entire
fairness review.”
• Notably, that Court stated that the complaint in MFW would have
survived a motion to dismiss based on allegations attacking the
fairness of the price, which called into question the adequacy of
the special committee’s negotiations.
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Delaware Developments: Standard of Review
• In SEPTA v. Volgenau, the Court of Chancery held that a merger
between a corporation with a controlling stockholder and a thirdparty private equity buyer was entitled to review under the
business judgment rule due to the use of “robust procedural
protections.”
• Distinguishing MFW because the controller in MFW stood on both
sides of the transaction, the Court of Chancery held that the
business judgment rule would nonetheless apply if the procedural
protections set forth in In re John Q. Hammons Hotels Inc. S’holder
Litig. were met, namely:
– Transaction recommended by disinterested and independent special
committee;
– Special committee had sufficient authority and opportunity to bargain on
behalf of minority (including the ability to hire independent advisors);
– Transaction approved by stockholder in non-waivable majority of minority
vote; and
– Vote was fully informed and non-coercive.
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Delaware Developments: Standard of Review
• In In re Morton’s Restaurant Group, Inc. S’holder Litig., the Court of
Chancery granted defendant’s motion to dismiss where alleged
controlling stockholder shared a control premium pro rata with
minority stockholders in a third-party deal.
• The Court of Chancery stated:
– “[T]he presumption is that a large blockholder, who decides to take
the same price as everyone else, believes that the sale is attractive,
and thus is a strong indication of fairness and that judicial deference is
due . . . there are only ‘narrow circumstances’ where a controlling
stockholder's desire to sell in a transaction according equal treatment
to all stockholders would create a disabling conflict of interest. Those
unusual circumstances ‘involve a crisis, a fire sale’ in which . . . the
controller imposes pressure on the corporation to artificially truncate
the market check and forgo the additional value that could be brought
about by making ‘logical buyers aware’ that the company is for sale
and giving them a reasonable time and fair opportunity to consider
whether to make an offer.”
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Delaware Developments: Appraisal Rights
• Appraisal rights experience in Michael Dell’s buyout of
Dell, Inc.
• Appraisal rights experience in David Murdock’s
acquisition of Dole Food Company, Inc.
• Trends in use of appraisal rights by stockholders
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Delaware Developments: Appraisal Rights
• In Huff Fund Investment Partnership v. CKx, Inc., in connection with
an appraisal proceeding in which the Court of Chancery held that the
best indicator of value of petitioner’s shares was the merger price
generated by an arm’s length sales process, the respondent filed a
motion seeking the Court to order the petitioner to accept an
unconditional offer that represented the base case scenario, plus
accrued interest, in order to stop the accrual of interest while the
parties supplemented the record as to whether the merger price
included synergies that should be excluded.
• Despite noting that, “compared to fault-based litigation, the
opportunities for rent-seeking in appraisal actions are comparatively
high” and that permitting a respondent to cut off the accrual of
interest may have merit for policy reasons, the Court held permitting
the respondent to do so was incompatible with the balance struck by
the General Assembly in amending Section 262 and limiting the
Court’s discretion in determining the proper rate at which interest
would accrue.
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Delaware Developments: Appraisal Rights
• In Huff Fund Investment Partnership v. CKx, Inc., in connection with
an appraisal proceeding in which the Court of Chancery held that the
best indicator of value of petitioner’s shares was the merger price
generated by an arm’s length sales process, the respondent filed a
motion seeking the Court to order the petitioner to accept an
unconditional offer that represented the base case scenario, plus
accrued interest, in order to stop the accrual of interest while the
parties supplemented the record as to whether the merger price
included synergies that should be excluded.
• Despite noting that, “compared to fault-based litigation, the
opportunities for rent-seeking in appraisal actions are comparatively
high” and that permitting a respondent to cut off the accrual of
interest may have merit for policy reasons, the Court held permitting
the respondent to do so was incompatible with the balance struck by
the General Assembly in amending Section 262 and limiting the
Court’s discretion in determining the proper rate at which interest
would accrue.
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Delaware Developments: Appraisal Rights
• In In re Orchard Enterprises, Inc. S’holder Litig., the Court of Chancery
held that quasi-appraisal was not a remedy limited to a short-form
merger and that if the defendants failed to prove that the merger was
entirely fair, then quasi-appraisal damages would be one form of
possible remedy. The Court explained:
– “[Q]uasi-appraisal damages are one possible remedy for breaches of the
duty of disclosure, and the availability of the quasi-appraisal damages
measure is not limited to short-form mergers. But more importantly . . .
the quasi-appraisal damages measure is simply a remedy, and it can be
awarded for other breaches of fiduciary duty as well.”
• As to the issue of which defendants would be liable for the payment
of such damages, the Court noted would be a “separate inquiry” in
which “affirmative defenses like exculpation under Section 102(b)(7)
and reliance on experts under Section 141(e) potentially apply.”
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Delaware Developments: Forum Selection
• Many Delaware corporations have adopted charter and bylaw
provisions designating Delaware as the exclusive forum for
stockholder litigation over derivative claims, breach of
fiduciary duty claims, and other internal affairs matters.
• In Boilermakers Local 154 Retirement Fund v. Chevron Corp.,
stockholders challenged the facial validity of the forum
selection bylaws adopted by Chevron and Fedex.
• The Court of Chancery held that the forum selection bylaws
were valid under Section 109(b) of the DGCL because:
– the bylaws “only regulated suits brought by stockholders as
stockholders in cases governed by the internal affairs
doctrine . . . the bylaws plainly relate to the ‘business of the
corporation,’ the ‘conduct of [its] affairs,’ and regulate the
‘rights or powers of [its] stockholders.’”
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Delaware Developments: Forum Selection
• Treatment of forum selection clauses in non-Delaware
courts:
– Miller v. Beam Inc.: Circuit Court for Cook County Illinois
enforces Beam’s board adopted forum selection bylaw (2014)
– In re Metro PCS Communications: Court of Appeals for Fifth
District of Texas enforces Metro PCS’s bylaw provision (2013)
– In re Facebook, Inc.: U.S. District Court SDNY declines to
enforce forum selection charter provision on technical grounds
(2013)
– Galaviz v. Berg: U.S. Federal District Court for N.D. California
declines to enforce Oracle’s board adopted forum selection
bylaw (2011)
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Delaware Developments: Additional Developments
• In Kalisman v. Friedman, a director designee sued the corporation
and his fellow directors for allegedly freezing him out of deliberations
regarding a recapitalization plan that he, and the stockholder that
designated him, opposed.
• Rejecting defendants’ argument that the director was frozen out
because he would have shared information provided to the board
with the stockholder that designated him, the Court of Chancery
noted:
– “When a director serves as the designee of a stockholder on the board,
and when it is understood that the director acts as the stockholder’s
representative, then the stockholder is generally entitled to the same
information as the director.”
• Importantly, however, the Court of Chancery noted that the director
remains liable for any misuse of the shared information.
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Delaware Developments: Additional Developments
• In In re Primedia, Inc. S’holders Litig., the Court of Chancery
held that plaintiffs, whose standing to pursue derivative insider
trading claims had been extinguished by a merger, had standing
to challenge directly the entire fairness of the merger based on
a claim that the target board of directors failed to obtain
sufficient value in the merger for the pending derivative claims.
• The Court determined that the plaintiffs established standing to
sue by showing that:
– The allegations stated a claim,
– The value of the claim was material in the context of the merger since
full disgorgement of profits for a fiduciary’s insider trading was a
potential remedy, and
– The acquiror was interested in the value of the business, rather than
in asserting the derivative claim, and did not provide value for the
claim in the merger price.
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Delaware Developments: Additional Developments
• In Activision Blizzard, Inc. v. Hayes, the Delaware Supreme
Court reversed the Delaware Court of Chancery’s injunction
of Vivendi’s sale of its controlling stake in Activision pursuant
to a stock purchase agreement.
• The Delaware Supreme Court held that a provision in
Activision’s charter that required the approval of a majority
of the stockholders not affiliated with Vivendi with respect to
any “business combination” or “similar transaction” did not
apply to the stock sale because the term “business
combination” was unambiguous and the stock sale did not
“involve any combination or intermingling of Vivendi’s and
Activision’s businesses.”
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