It sure seems like the “entire fairness” standard ain’t what it used to be. Back when I had hair, Delaware courts referred to the choice of whether to apply the business judgment rule or the entire fairness standard as often being “outcome determinative.” But more recently, some Delaware decisions have shown that entire fairness is a standard that sometimes can be navigated – even if the defendant retains the burden of proof to establish a deal’s fairness.
It looks like we can add the Chancery Court’s recent decision in Hsu Living Trust v. Oak Hill Capital Partners, (Del. Ch.; 5/20), to the list of those decisions. The case involved allegations that the controlling shareholder & its representatives on the board breached their fiduciary duties by causing the company to adopt a strategy designed to accumulate cash in anticipation of a redemption of the controller’s preferred shares.
The plaintiff established that implementation of this strategy provided unique benefits to the controller, so Vice Chancellor Laster decided that the plaintiff’s claims should be evaluated under entire fairness standard should apply. Nevertheless, the Vice Chancellor determined that the defendants satisfied their burden of proving that the challenged strategy was entirely fair. Steve Quinlivan’s recent blog on the case summarizes VC Laster’s reasoning:
As is well known, the concept of fairness has two basic aspects: fair dealing and fair price. The fair process dimension of the entire fairness inquiry examines the procedural fairness of the decision, transaction, or result being challenged. It considers the manner in which the challenged decision, transaction, or result came about.
The Court found the defendants fell short on this dimension of the analysis. The reasons appear to be that Oak Hill directed management’s actions and the lack of Board approval of the cash accumulation strategy. Noting that Hsu only challenged the cash accumulation strategy, and not the decision to redeem shares or the prices at which assets were sold, the Court found the lack of process was not fatal.
The reason was that although the two aspects –fair dealing and fair price — may be examined separately, they are not separate elements of a two-part test. The test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.
The fair price dimension of the entire fairness inquiry examines the substantive fairness of the decision, transaction, or result being challenged. In the traditional formulation, it relates to the economic and financial considerations of the transaction under challenge, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock.
The defendants proved at trial that the cash-accumulation strategy was entirely fair. The defendants proved by a preponderance of the evidence that the Company declined not because of the cash-accumulation strategy, but rather because of industry headwinds and relentless competition, most notably from Google, Inc.
The Vice Chancellor also found that the defendants had proven that an alternative strategy would not have produced greater value for the common stockholders. In reaching this conclusion, he noted that Oak Hill was also a substantial holder of the common stock and that, while it had an incentive to fund the redemption of its preferred stock, it also had an incentive to create value for the common.
– John Jenkins