May 19, 2014
Delaware Supreme Court Affirms Extension of MFW Beyond Controller Buyouts
Here’s news from Lisa Stark of Berger Harris:
In Southern Pennsylvania Transportation Authority (“SEPTA”) v. Volgenau, C.A. No. 461, 2013 (Del. May 13, 2014), the Delaware Supreme Court affirmed a Chancery Court decision holding that a sale of a controlled corporation to an unaffiliated third party, in which a controller (while not on both sides of the transaction) was alleged to have used his position to compete with the minority for merger consideration, would be reviewed under the deferential business judgment standard of review if the transaction is (1) recommended by a disinterested and independent special committee and (2) approved by stockholders pursuant to a non-waivable vote of the majority of all the minority stockholders.
Sales of Controlled Corporations to Unaffiliated Third Parties
The Delaware Supreme Court did not issue a written opinion in connection with this en banc ruling. However, the decision to affirm the Chancery Court decision in SEPTA is significant because it confirms the standard of review applicable to transactions in which the controller is alleged to have used its power to disproportionally divert portions of the merger consideration to be paid by an unaffiliated, third-party acquirer to the minority if the controlled target deploys robust procedural protections. In the 2009 Chancery Court decision in In re John Q. Hammons Hotels Inc. Shareholder Litig., the Court of Chancery held that the business judgment rule would apply to such a situation only if the merger was subject to (1) a non-waivable vote of a majority of the minority stockholders, and (2) a recommendation by a disinterested and independent special committee. In In re John Q. Hammons Hotels Inc. Shareholder Litig., the Court found the transaction at issue to be subject to entire fairness review because, although the transaction was subject to a majority of the minority vote, the special committee could waive the condition and the vote only required a majority of the minority voting on the matter, not a majority of the outstanding minority stockholders.
Subsequent Chancery Court decisions, such as Frank v. Elgamal, reaffirmed that, absent the procedural protections of a special committee and a majority of the minority vote, the Court of Chancery would apply the entire fairness standard of review to mergers of controlled corporations to an unaffiliated third party if the controller is alleged to have used its power to unfairly extract merger consideration from the minority or otherwise to have dictated certain aspects of the negotiations contrary to the interests of the minority.
SEPTA v. Volgenau
Unlike MFW, which involved a controlling stockholder on both sides of the transaction, SEPTA involved a merger between a third-party and a company with a controlling stockholder. Specifically, this action involved claims arising from the buy-out of defendant SRA International, Inc. (“SRA”) by Defendants Providence Equity Partners LLC and its related entities. See SEPTA. v. Volgenau, C.A. No. 6354-VCN (Del. Ch. Aug. 31, 2012). As a public company, SRA had two classes of common stock: Class A and Class B. Holders of Class A stock were entitled to one vote per share, while holders of Class B stock were entitled to ten votes per share. However, SRA’s certificate of incorporation required the Class A and Class B common stock be treated equally in the event of a merger. As part of the transaction, SRA’s founder, Ernst Volgenau, who controlled SRA through his ownership of Class B shares, received a minority interest in the merged entity, a non-recourse note, a continuing role in the merged entity, and, in exchange for fifty-nine percent of his Class B shares, $31.25 per share in cash. Minority stockholders, who held Class A Shares, received $31.25 per share.
In this action, plaintiff contended that Volgenau received greater consideration in the merger than did the minority stockholders and that the board breached its fiduciary duties by failing to attempt to adhere to the charter’s equal treatment provision. However, because the transaction had been approved by a special committee comprised of independent and disinterested directors, and a fully informed, non-waivable majority of the minority vote, the Court reviewed the allegations under the deferential business judgment standard of review.
The decision to uphold the application of the business judgment rule to sales of controlled corporations to unaffiliated third parties where the transactions are subject to the same procedural protections at issue in MFW makes sense. In theory, transactions in which the controller is not on both sides of the deal present less potential for the controller to exert influence to the detriment of the minority stockholders.