May 5, 2020

Controllers: When Does a Minority Holder “Roll” Its Way into Control?

It isn’t unusual for one or more target shareholders to “roll” their equity interests over into the acquiring entity. But if the deal involves a controlling shareholder, when will the equity rollover result in minority holders becoming part of the control group that’s subject to fiduciary duties?  The Delaware Chancery Court recently addressed that issue in Gilbert v. Perlman, (Del. Ch.; 4/20).

The case involved the rollover of investments held by the holder of an 11% interest in Connecture and the company’s chairman (who held less than 1%, but was also affiliated with the 11% holder). The plaintiffs alleged that, as a result of their participation in the transaction, they were part of a control group with the company’s majority stockholder.  Vice Chancellor Glasscock rejected that allegation.

Citing Delaware precedent, the Vice Chancellor said that two elements must be established in order for a minority shareholder to be considered part of the control group. First, the minority holder must be connected to the controlling shareholder in a legally significant way (such as through a contract) to work together toward a common goal. Second, the plaintiff must also demonstrate that the minority holder’s participation was material “to the controller’s scheme to exercise control of the entity, leading to the controller ceding some of its control power” to the minority holder.

This Paul Weiss memo on the case says that although the Vice Chancellor felt that the plaintiffs established the first prong of the test, he concluded that they fell short when it came to the second:

Plaintiffs pointed to various factors indicating the existence of a control group, including that (i) SEC rules defined the minority and majority stockholders as “affiliates” and they filed a Schedule 13E-3 stating, among other things, whether they believed the merger was fair to the company’s unaffiliated security holders, (ii) the 11% stockholder entered into a voting agreement with the controller requiring it to vote its shares in favor of the merger, and (iii) the minority stockholders previously participated in two private placements alongside the controller.

In his opinion, Vice Chancellor Glasscock acknowledged that these allegations were sufficient to satisfy the first prong of the control group test, finding the allegations supported an inference that there was a legally significant connection among the stockholders beyond mere parallel interests in supporting the merger.

However, the court reasoned that the second prong was not satisfied because the majority stockholder could approve the merger “entirely on its own” without minority participation, and plaintiffs did not allege anywhere in the complaint that the controller’s “sharing or material self-limiting of its control powers” to obtain participation of the minority stockholders for its “perceived self-advantage.”

The court said that the complaint “describes nothing [the controller] needed or ceded to the [minority stockholders], other than the bare right to roll over shares,” and the controller’s willingness to dilute its interest by permitting the rollover was not enough to satisfy this second prong.

John Jenkins