June 17, 2021

Controllers: Receipt of Unique Benefits Results In Entire Fairness Review

In In re Tilray, Inc. Reorganization Litig., (Del. Ch.; 6/21), the Delaware Chancery Court held that the founding shareholders of Tilray constituted a “control group,” and that they received non-ratable benefits in a tax-driven reorganization transaction. As a result, Chancellor McCormick held that the transaction was subject to review under the entire fairness standard. Here’s an excerpt from this Shearman blog discusses the Chancellor’s reasoning:

The Court held that plaintiffs adequately pleaded that the founders comprised a control group as the complaint alleged a “concurrence of interests” among the founders along with several “plus factors.”  Specifically, the Court found that plaintiffs sufficiently alleged that the founders collectively shared a “desire to avoid massive tax liability associated with the substantial increase on [their] initial investment,” which was “not shared by other . . . stockholders.”

The Court also found that plaintiffs adequately alleged “historically and currently significant ties and transaction-specific ties among the [f]ounders,” including that they (i) were “long-time friends”; (ii) founded the parent and jointly managed the Company and other portfolio companies; (iii) “held each other out as ‘partners’” and defined themselves in organizational documents as the “Founders”; and (iv) negotiated the reorganization collectively.

The Court also rejected defendants’ contention that entire fairness review did not apply because the tax benefits “were not extracted from and were never available to [the Company’s] minority stockholders” and the reorganization “caused no detriment to the minority.”  The Court instead found that multiple decisions have held that “entire fairness presumptively applies whenever a controller extracts a non-ratable or unique benefit.”

Even if some detriment to the minority shareholders is required in order to invoke entire fairness, the Chancellor held that the complaint’s allegations that the board failed to exert its leverage over the founders to the detriment of the minority were sufficient to establish it.

John Jenkins