October 13, 2009

Controlling Stockholders and Control Premiums

– by Steven Haas, Hunton & Williams

The ACS/Xerox $6.4 billion merger has received significant attention lately. Among the interesting issues in the transaction is the right of the controlling stockholder to receive a control premium. Steven Davidoff (aka the “Deal Professor”) has must-read blog posts on the transaction here and here.

The deal has commentators talking particularly about the implications of Chancellor Chandler’s 2005 opinion in In re Telecommunications. There, the Chancellor said that “[r]easonably construing the facts in favor of plaintiffs, if [the controlling stockholder] wished to be fair, then he could have shared some part of the value of his own stock holdings].” I don’t think that statement altered Delaware law on the right of a controlling stockholder to receive a control premium. The Chancellor was responding to the argument that all holders of TCI’s high-vote shares were entitled to a premium, and he seemingly suggested that the controller could have diverted his own consideration to the other holders of high-vote shares. As the Deal Professor surmises, the Chancellor basically was saying “Look, [the controller] could have taken less and avoided this litigation.”

Fortunately, this issue just received some additional clarity: In In re John Q Hammons Hotels Inc. S’holder Litig., decided a few weeks ago, Chancellor Chandler held that the entire fairness standard set forth in Lynch Communication is not automatically triggered whenever a controller receives consideration that is different from that paid to minority stockholders in a third-party merger. Moreover, the Chancellor explained his holding in TCI:

[I]n In re Tele-Communications, Inc. Shareholders Litigation, the evidence suggested that a majority of the board of directors was interested because they received material personal benefits from the transaction they approved. Specifically, the transaction materially benefited a majority of the directors because it allocated a disproportionate amount of the merger consideration to the directors’ class of stock. Moreover, only one of those directors was a controlling stockholder entitled to a control premium.

Thus, the interestedness of a majority of the directors led the Court to apply the entire fairness standard and to conclude that, as in Lynch, the approval of the transaction by the stockholders and a special committee could at most shift the burden of demonstrating entire fairness to plaintiffs. Here, in contrast, [the controller] negotiated with [the buyer] and did not participate in the negotiations between [the buyer] and the special committee. Nothing in In re Tele-Communications mandates the extension of Lynch to this case.

Although Hammons applied entire fairness due to other perceived defects in process, it indicates that TCI hinged largely on the absence of a majority of disinterested directors. Of course, whether the size of a particular premium is appropriate may be a factual issue for a court to determine. But TCI should not be understood as undercutting a controlling stockholder’s basic right to a premium. Since controllers can freely vote down third-party proposals for “whim or caprice,” judicial restraints on paying a control premium will only impede transactions from taking place.

Hammons is also notable for making clear that majority-of-the-minority provisions must be (1) non-waivable and (2) based on a majority of the outstanding minority shares, not a majority of the minority shares actually voted. As to the first point, the court faulted the special committee’s ability to waive the MOM–even thought it didn’t. As to the latter point, Vice Chancellor Strine made a similar observation in 2006 in PNB Holding Co., a decision decided well after the Hammons merger was effected.

We have begun posting memos analyzing this case in our “Minority Shareholders” Practice Area.