March 5, 2021

Controllers: What’s The Standard of Review for a Sale to a Third Party?

Last month, I blogged about Vice Chancellor Laster’s decision in  Firefighters’ Pension System v. Presidio, (Del. Ch.; 1/21).  In that blog, I focused on the aiding & abetting claims against the buyer, but I noted that there was a lot more going on in that case. This Paul Hastings memo focuses on another important aspect of the decision – the standard of review that should be applied to a sale of a controlled company to a third party.

Prior to Presidio, Delaware appeared to have adopted a “safe harbor” position under which, a sale of a controlled company to an unaffiliated third party in which all shareholders received the same consideration would generally be evaluated under the business judgment rule. That position was first announced by then-Chancellor Strine in In re Synthes Stockholder Litigation, (Del. Ch.; 8/12), and was prompted in large part by the recognition that controlling stockholders are typically well-suited to help the board maximize the value achieved in a third party sale.

In order to reach that position, Chancellor Strine first had to deal with the Supreme Court’s 2000 decision in McMullin v. Beran.  In that case, the Court held that a controlled company’s sale to a third party implicated Revlon, and also said that a duty of loyalty claim could be filed against the controller for negotiating an “immediate all-cash [t]ransaction” to satisfy a liquidity need based on allegations that the company’s full value “might have been realized in a differently timed or structured agreement.”

Chancellor Strine dealt with McMullin in a lengthy footnote, and explained that the conclusion that  a controlling shareholder was somehow “disloyal” in accepting an all-cash deal involves a legal and financial non-sequitur:

“[T]his reasoning glosses over the reality that the present value of stock depends on the currency value into which it can be converted, plain and simple. For example, let’s imagine that there had been another bidder in McMullin that offered a nominally higher per share price (let’s say, $60.00 per share, as opposed to $57.75 per share consideration offered in that case) with consideration in the form of 100% stock. Imagine further that the stock was easily convertible into cash. All things being equal, the controlling stockholder would have no reason to prefer a cash deal at $57.75 per share when it could get a stock deal at $60.00 per share and simply sell the stock on the market to get that higher value in cash, assuming minimal transaction costs.”

Strine noted if a bidder’s currency cannot be turned into cash at its purported value, then it is not worth what it purports to be worth – and the controller is under no obligation to take less value for its shares than the minority shareholders (who might not face the same discounts when it came time to dispose of their shares) receive.

The memo notes that Vice Chancellor Laster took a different position in Presidio. He cited McMullin as establishing the principle that a controlled company’s sale to a third party was subject to Revlon, and because the Supreme Court had established that standard, he felt that it was inappropriate to rely on the safe harbor created in Synthes.  Instead, VC Laster concluded that Corwin was the only route to a safe harbor in this situation, but as this excerpt from the memo notes, it isn’t entirely clear how Corwin should apply here:

To restore the safe harbor of the business judgment rule, Presidio would require approval of the sale from the affirmative vote of a majority of the disinterested shares pursuant to Corwin v. KKR Financial Holdings, LLC,  While Presidio does not address the issue directly, the decision raises the question whether such approval must come from the minority stockholders. Indeed, if Presidio and Corwin would provide safe harbor protection for the sale of a controlled company when the transaction is approved by the controlling stockholder, then that result is no different form the Synthes safe harbor. But because Presidio rejects the Synthes safe harbor,  the Presidio decision could be read as requiring the informed vote of a majority of the minority stockholders.

Vice Chancellor Laster’s discussion of the approval required suggests that the nature of the vote required may well turn on the analysis of whether there are plausible allegations that the transaction involves disparate interests between the controller & the minority – which would seem to put us back in the position of having to address Chancellor Strine’s argument that such allegations of such a disparity would be a legal and financial non-sequitor.

John Jenkins