February 13, 2020
Controllers: The Heat is On in Delaware for Minority Shareholders
In my recent blog about the Chancery Court’s Essendant decision, I mentioned that plaintiffs have increasingly been asserting “controlling shareholder” claims against minority shareholders in merger objection lawsuits. A pair of recent decisions demonstrate that these claims can gain traction even in situations where the minority shareholder’s stake represents less than 40% of a company’s voting power.
In 2018, Vice Chancellor Slights declined to grant a motion to dismiss claims arising out of Tesla’s acquisition of Solar City that were premised on Elon Musk’s status as a controlling shareholder of Tesla. The Vice Chancellor reached that conclusion despite the fact that Musk held only 22% of Tesla’s stock. Last week, in a 37-page opinion, he reached the same conclusion in denying the defendants motion for summary judgment.
The Tesla defendants argued that Delaware precedent on controlling shareholders’ “inherently coercive” power only allowed claims to survive pleading-stage motions to dismiss. They contended that after discovery has been completed, plaintiffs have to “put up or shut up” by providing proof that the purported controlling shareholder put its thumb on the scales. In the absence of that proof, the Corwin doctrine should apply & the deal should be subject to business judgment review.
As Alison Frankel pointed out in her recent column on the decision, VC Slights declined to accept Tesla’s position that the notion of “inherent coercion” by a controlling shareholder “evaporates when the case moves beyond the pleading stage.” Here’s an excerpt:
Vice-Chancellor Slights hailed that “ingenious” argument – but rejected it. Delaware courts developed their precedent on the coercive power of controlling shareholders because they understand how the world works, he said: The ability to control is self-fulfilling. And though the vice-chancellor conceded that even some of the Delaware jurists who originated the theory have subsequently questioned it in a law review article, the presumption that a controlling shareholder has inherently coercive power remains good law.
Of course, Slights said, to invoke the entire fairness standard of review, investors must still show that Musk was, in fact, a controlling shareholder by dint of his outsized influence at the company. And even if shareholders clear that hurdle, Musk can still prove at trial that the SolarCity deal was fair, which is exactly what defense lawyers have been arguing since the case began.
Musk’s bad day at the office wasn’t the only disturbing news for holders of large minority stakes this month. On Monday, Vice Chancellor Laster issued his opinion in Voigt v. Metcalf, (Del. Ch.; 2/20), in which he declined to dismiss claims that Clayton Dubilier & Rice, which held 35% of the stock in NCI Building Systems, was a controlling shareholder for purposes of breach of fiduciary duty claims arising out of that company’s acquisition of its portfolio company.
The opinion says that indicia of control cited by the plaintiff in that case included:
CD&R’s control over 34.8% of its voting power, the presence of four CD&R insiders on the Company’s twelve-member board of directors (the “Board”), relationships of varying significance with another four directors, and a stockholders agreement that gives CD&R contractual veto rights over a wide range of actions that the Board could otherwise take unilaterally.
Vice Chancellor Laster ultimately concluded that these allegations of control were sufficient to withstand a motion to dismiss, and that the plaintiff also adequately alleged facts that called into question the fairness of the transaction.
When you consider that these decisions come on the heels of successful allegations of minority controller status in the BlackRock Mortgage Ventures decision & the unsuccessful ones in the Essendant litigation, it sure looks like Prof. Ann Lipton was on to something when she said that a boom in lawsuits alleging controller status was likely to be an unintended consequence of the rise of the Corwin doctrine.
– John Jenkins