Recent Delaware court decisions have underscored the value of procedural safeguards in controlling stockholder transactions—which, at least when involving minority freeze-outs, historically were subject to entire fairness review, Delaware’s most demanding level of judicial scrutiny. Where, however, controlling stockholder transactions are conditioned at the outset on an effective special committee process and an informed majority of the minority shareholder vote, they may be protected by Delaware’s deferential business judgment rule. The Court of Chancery’s recent decision in IRA Trust FBO Bobbie Ahmed v. Crane extending such protection to a stock reclassification transaction confirms that the utility of procedural protections in controlling stockholder transactions avails itself broadly, even to transactions not involving minority freeze-outs.
In view of this recent case, corporate boards and controllers considering a controlling stockholder transaction should weigh carefully the merits of employing both a special committee process and an unconditional majority-of-the-minority vote requirement, as the benefits of these dual procedural enhancements may be considerable if the transaction is challenged in litigation.
Historically, freeze-out transactions between a corporation and its controlling stockholder challenged by a minority shareholder were subject to Delaware’s most exacting level of judicial scrutiny: entire fairness review. In 2014, the Delaware Supreme Court affirmed that the deferential business judgment rule will be applied if the challenged freeze-out transaction was conditioned at the outset on two safeguards that, in combination, replicate a disinterested, arms-length negotiation construct:
- an effective special committee process, and
- an effective majority of the minority vote (i.e., the affirmative, informed vote of a majority of the shares owned by stockholders who are not affiliated with the controller). Kahn v. M & F Worldwide, Corp., 88 A.3d 635 (Del. 2014).
In a recent case, IRA Trust FBO Bobbie Ahmed v. Crane
, C.A. No. 12742-CB (Del. Ch. Dec. 11, 2017), the Court of Chancery extended the MFW holding to a transaction involving a reclassification of stock that perpetuated the controller’s voting control position.
involved NRG Yield, Inc. (“Yield”), a Delaware corporation that owned a portfolio of income-producing energy generation and infrastructure assets from which dividends were distributed to public stockholders. Yield was managed and controlled by NRG Energy, Inc. (“NRG”). To maintain its voting control, NRG proposed that Yield reclassify its stock, subject unconditionally to approval by a majority of Yield’s minority stockholders. Yield designated a three-member special committee to evaluate and negotiate NRG’s proposal. After back and forth with the special committee, NRG’s proposal was revised so that Yield would establish two new classes of common stock, Class C and Class D, that would be distributed on a one-for-one basis to Class A and Class B stockholders. NRG also agreed to amend its right of first offer agreement with Yield, making additional assets potentially available to Yield. Upon the special committee’s unanimous recommendation, the board approved the reclassification and recommended it to Yield’s minority stockholders. Shortly after, a majority of the outstanding shares of Class A stock unaffiliated with NRG approved the proposal.
The transaction was challenged by a Class A stockholder (purporting to sue on behalf of a putative class) who alleged breach of fiduciary duty claims against (a) the Yield board members for approving the reclassification and (b) NRG for causing Yield to undertake the reclassification. The Rule 12 motion to dismiss that followed gave rise to three questions:
- was the reclassification a conflicted transaction
- if yes, should the analytical framework in MFW, a squeeze-out merger case, apply, and
- if yes, had that framework been satisfied in this case on the face of the pleadings?
the Court found that NRG received a benefit to the exclusion of the minority stockholders—the means to perpetuate its control by financing future acquisitions with the low-vote Class C stock authorized in the reclassification. Therefore, the reclassification was a conflicted controller transaction.
the Court determined that MFW applied to the reclassification, explaining that there was no compelling basis to limit the MFW framework to squeeze-out mergers. The Court observed that if the MFW protections are employed, it replicates an arm’s-length bargaining process; therefore “the use of these types of protections should be encouraged to protect the interests of minority stockholders in transactions involving controllers.”
the Court determined that the process Yield employed satisfied the MFW framework. To aid in determining whether the dual protections were effective, MFW set forth six elements:
- the controller conditions the transaction at the outset on the approval of both a special committee and a majority of the minority stockholders at the outset
- the special committee is independent
- the special committee is empowered to freely select its own advisors and to say no definitely
- 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.
The Court determined the plaintiff had failed to challenge sufficiently the satisfaction of any of these six elements. Thus, the Court held that the reclassification was subject to business judgment deference. Because the plaintiff’s allegations did not overcome this deferential standard, plaintiff’s fiduciary duty claims were dismissed.
In Crane, the Delaware Court of Chancery once again endorsed procedural safeguards together replicating an arms-length transaction process—this time in the context of a stock reclassification. Where these two procedural enhancements have been faithfully and effectively implemented, transactions with controllers will be accorded business judgment deference.