February 5, 2020

Controllers: Chancery Refuses to Dismiss “Control Group” Claim

In Garfield v. BlackRock Mortgage Ventures, (Del. Ch.; 12/19), the Delaware Chancery Court held that a plaintiff challenging a corporate reorganization had adequately pled the existence of a control group among various institutional investors.  As a result, the court declined to apply the Corwin doctrine to insulate the transaction from a post-closing challenge.

The lawsuit challenged the fairness of a corporate reorganization involving PennyMac Inc. that unwound its “Up-C” corporate structure.  The plaintiff alleged that the transaction created benefits for the defendants – who held high-vote Class B stock of the parent along with units in a subsidiary – but not for the parent’s Class A stockholders. The plaintiff argued that the defendants were controlling stockholders, and that the transaction should be reviewed under the entire fairness standard.

The defendants moved to dismiss. They argued that they should not be regarded as  controlling shareholders, and that they should obtain the benefit of the business judgment rule under Corwin because a majority of disinterested stockholders approved the transaction.  Vice Chancellor McCormick disagreed.  This excerpt from a recent Morris James blog on the case explains her reasoning:

The Court declined to grant the defendants’ motions to dismiss, because the plaintiff had sufficiently alleged that BlackRock and HC Partners should be considered a “control group” with fiduciary duties. Together, they controlled 46.1 percent of the vote, they had unilateral rights under the LLC agreement to veto the reorganization, and they had the right to designate four of eleven members of PennyMac, Inc.’s board of directors.

In total, this supported the inference that they at least had transaction-specific control for the reorganization if they worked together. Following recent Delaware decisions – including Sheldon v. Pinto and In re Hansen Medical Shareholders Litigation – the Court also examined the ties between BlackRock and HC Partners to find that they had agreed to act as a group.

Prior dealings between the two defendants included their joint investment in the operating subsidiary &  their joint participation in the negotiation of the reorganization. The defendants also negotiated a provision requiring the consent of both of them in order to terminate the reorganization. VC McCormick concluded that plaintiff had adequately pled that the defendants were a “control group” as well as facts that raised issues as to the fairness of the transaction.

John Jenkins