March 12, 2020

Controllers: Minority Blocking Rights May Confer Control Status

There’s been a lot of action in Delaware recently about when holders of less than a majority equity stake in an enterprise may be regarded as controlling shareholders.  This Fried Frank memo reviews Skye Mineral Investors, LLC v. DXS Capital (U.S.) (Del. Ch.; 2/20), the latest Delaware case to address this issue.

In the Skye decision – which involved a limited liability company – Vice Chancellor Slights held that under the right alignment of planets, contractual “veto rights” could put minority holders in the position of exercising actual control over a company.  Here’s the memo’s intro:

In Skye Mineral Investors, LLC v. DXS Capital (U.S.) Limited (Feb. 24, 2010), the Delaware Court of Chancery found, at the pleading stage, that it was reasonably conceivable that the two key minority members of Skye Mineral Partners, LLC (“SMP”) had breached their fiduciary duties to SMP and the other members by intentionally using the contractual veto rights they had under SMP’s LLC Agreement to harm SMP and increase their own leverage. Also, the court found that members of the group that controlled these minority members, as well as certain affiliates of that group, may have aided and abetted the fiduciary breaches.

In addition, the court found that one of these minority members and its authorized observer on the SMP board breached their confidentiality obligations by using information they learned, through the observation right, to advance the member’s interests at SMP’s expense.

The decision serves as an explicit reminder of the fiduciary and other obligations that LLC members and managers (and their affiliates) may have when the LLC agreement does not clearly and unambiguously provide otherwise. Further, the decision indicates that, under unusual circumstances, minority members may find themselves in the unexpected position of having fiduciary obligations as controllers–if their veto rights under the LLC agreement have put them in a position of “actual control” of the LLC (and particularly if they use that control to advance their own interests while harming the company).

This case shouldn’t be read as saying that any strong contractual right provided to a minority shareholder will result in it being considered a controller.  Delaware’s approach is more nuanced.  For example, in Superior Vision Services v. ReliaStar, (Del. Ch.; 8/06), the Chancery Court declined to find that a minority shareholder’s exercise of a contractual right to block a dividend made it a controlling shareholder, noting that the shareholder did not control the Board’s decision making process concerning the declaration of a dividend. The Court said that to hold otherwise would result in “any strong contractual right, duly obtained by a significant shareholder…, [being] limited by and subject to fiduciary duty concerns.”

As the memo points out, the key factors in Vice Chancellor Slights’ decision in the Skye case included the that the contract right in question was so powerful that it in effect gave the minority “the unilateral power to shut SMP down,” and that the minority holders allegedly exercised their blocking right “as part of a ‘scheme to harm the company’ and advance their own interests.”

John Jenkins