Delaware

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Seal_of_the_Supreme_Court_of_Delaware_svgThe Delaware Supreme Court will address the standard for pleading that an independent director has breached fiduciary duties in connection with a controlling shareholder buyout. The issue was certified for interlocutory appeal in a pair of recent Delaware Chancery Court cases. In re Cornerstone Therapeutics Stockholder Litigation, No. CIV.A. 8922-VCG (Del. Ch. Sept. 10, 2014) (Glasscock, V.C.); In re Zhongpin Stockholders Litigation, No. CV 7393-VCN (Del. Ch. Nov. 26, 2014) (Noble, V.C.).

In Cornerstone and Zhongpin, minority shareholders sued after the controlling shareholder of a publicly-traded company attempted a going-private transaction. In both cases, the board of directors formed a special committee of independent directors to negotiate with the controller; however, neither deal was conditioned, at the outset, on approval of a majority of the minority shareholders. In both cases, the corporate charter contained a provision enacted pursuant to Delaware General Corporation Law 102(b)(7), which exculpated directors from liability for breach of the duty of care.

The D&O Diary featured a version of this post, entitled “New Debate in January on Delaware Bylaws re Shareholder Liability,” as a guest blog post. Many thanks to Kevin LaCroix of The D&O Diary for publishing our post.

The ability of corporations to impose liability on shareholders through bylaws and charter provisions has been the subject of much debate recently.  On May 8, 2014, the Supreme Court of Delaware held in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 555 (Del. 2014), that “a fee-shifting provision in a non-stock corporation’s bylaws can be valid and enforceable under Delaware law.” This decision (in favor of ATP, represented by Proskauer’s own Brad Ruskin) prompted a proposed amendment to the Delaware General Corporation Law (DGCL) that would eliminate the ability of Delaware stock corporations to impose liability on shareholders through bylaw and charter provisions, including fee-shifting liability, and a debate about the use of bylaws to define the bounds of shareholder litigation.  Act to Amend Title 8 of the Delaware Code Relating to the General Corporation Law, S.B. 236, 147th Gen. Assemb. (Del. 2014).  Senator Bryan Townsend, D-Newark, was able to delay the debate on the proposed legislation until the Delaware legislature reconvenes in January 2015.

In NAF Holdings, LLC v. Li & Fung (Trading) Limited, 2014 WL 6462825 (2d Cir. Nov. 19, 2014), the Second Circuit considered, but did not decide, whether the usual direct/derivative analysis governing minority stockholder claims against corporate fiduciaries should also apply to bar a contract claim against an unaffiliated outsider.  Finding itself unable to resolve this issue of first impression under applicable Delaware law, the Second Circuit certified the question to the Delaware Supreme Court.

This unusual question arose after a planned acquisition fell through.  NAF, a Delaware LLC, planned to acquire Hampshire.  NAF entered into a buying agent agreement with Li & Fung, which promised to serve as sourcing agent for Hampshire post-acquisition.  Thereafter, as is commonly done in M&A transactions, NAF formed two wholly-owned subsidiaries to effectuate the acquisition, and they entered into the merger agreement with Hampshire.  As NAF alleged in its complaint for breach of contract, Li & Fung wrongfully repudiated the buying agent agreement, which caused NAF to lose the financing commitments it needed to fund the subsidiaries’ acquisition of the Hampshire shares.  The acquisition thus could not be completed, resulting in a $30 million loss.

Originally published as a Proskauer Client Alert.

The New York Appellate Division, First Department, ruled yesterday that the business-judgment rule – not the entire-fairness standard of review – can apply to a going-private transaction with the majority shareholder where the majority shareholder did not participate in the board’s vote on the merger, the remaining directors were not alleged to be self-interested, and the merger required the approval of the majority of the minority shareholders.  In re Kenneth Cole Productions, Inc. Shareholder Litigation, Index No. 650571/12 (N.Y. App. Div. 1st Dep’t Nov. 20, 2014).

The ruling aligns New York law with Delaware law and provides greater protection for interested transactions implemented with procedural protections that obviate any coercion or conflicts of interest.

Introduction written by Tanya Dmitronow and Julia Pizzi. Full analysis written by Sarah Gold and Richard Spinogatti.

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In Kahn v. M&F Worldwide Corp., the Delaware Supreme Court unanimously affirmed the Court of Chancery’s decision that the business judgment standard, rather than the entire fairness standard of review, applies to controller freeze-out mergers where the controller’s proposal is conditioned at the outset on both Special Committee approval and a favorable majority of the vote.  The Court found that the dual protection measures instituted at the outset of the acquisition process sufficiently protected the minority shareholders’ interests.

The Court adopted the new standard articulated by the Court of Chancery, holding that business judgment review would only be available if all of the following conditions are met:

  1. The controlling stockholder from the outset makes the merger contingent on the approval of both a special committee and a majority-of-the-minority stockholder vote;
  2. The special committee is comprised of independent directors;
  3. The special committee is empowered to definitively reject the proposal, and to freely employ its own legal and financial advisors;
  4. The special committee meets it duty of care; and
  5. The minority is fully informed and uncoerced.