April 22, 2021

Controllers: Fiduciary Duties Don’t Include Martyrdom

In RCS Creditor Trust v. Schorsch, (Del. Ch.; 3/21), the Delaware Chancery Court confirmed that while fiduciary duties impose a number of demands on controlling shareholders, martyrdom isn’t one of them.  The issue boiled down to whether the controlling stockholder’s decision to advise the board that he was unwilling to support one of two competing financing transactions breached his fiduciary duties.  This excerpt from a recent Morris James blog summarizes the facts of the case:

RCS Capital Corporation (“RCS”) was a real estate investment trust servicing company in need of an equity infusion. To help resolve these liquidity problems, a potential transaction involving Apollo Global Management, LLC and AR Capital, LLC, (the “Apollo Transaction”) was presented to RCS’s Board. Because Apollo was affiliated with RCS’s controller, Nicholas Schorsch, a special committee was formed to review the transaction.

During the special committee process, an alternative to the Apollo Transaction arose involving Centerbridge Capital Partners III, L.P (the “Centerbridge Proposal”). The Centerbridge Proposal included terms unfavorable to Schorsch, including the loss of his controller status through a surrender of his preferred voting shares. Schorsch informed the special committee that he did not support the Centerbridge Proposal. Ultimately, in part because Schorsch’s continued opposition made the Centerbridge Proposal infeasible, the special committee recommended pursuing the Apollo Transaction.

Neither deal was completed, and RCS ultimately filed for bankruptcy. The plaintiffs subsequently sued the controller for allegedly breaching his fiduciary duties, contending that his statements opposing the Centerbridge transaction amounted to impermissible “threats” to the board.  Vice Chancellor Glasscock disagreed:

Of course, if a controller uses her voting control to bully directors, she has thereby assumed fiduciary duties. Such a threat robs the directors of the opportunity to put their business judgment on behalf of the entity over their own—now threatened—interests. Here, however, the Plaintiff points to no record  evidence that supports the existence of such a threat.

The “threat” alluded to here is simply a statement that Schorsch would vote his stock in his business interest, in not giving up his contractual rights and majority ownership in order to approve the Centerbridge deal. This is not a threat to the independence of the Special Committee; it is simply a business decision that Schorsch communicated to the committee. A stockholder does not forfeit the right to exercise contract rights or to vote her stock merely by being a controller. There is no duty for a controller to sacrifice on behalf of the company.

The Vice Chancellor’s opinion noted that the Special Committee didn’t act like it had been cowed in any way by the controller’s comments.  In fact, it continued to pursue the Centerbridge deal and declined to enter into an exclusivity arrangement with Apollo subsequent to the controller’s statement of opposition to the Centerbridge proposal.  VC Glasscock concluded that the Special Committee “acted independently within its business judgment, and that Schorsch and the other Defendants did nothing but inform the committee that Schorsch would vote against what he perceived as a personally unfavorable deal.”

John Jenkins