Courts generally recognize that controlling stockholders have an incentive to maximize stockholder value in a third-party sale, and even if that transaction is subject to entire fairness review, deal terms that provide the same per share consideration to all stockholders often provide compelling evidence of fairness. However, the Chancery Court’s recent decision in Manti Holdings v. The Carlyle Group, (Del. Ch.; 6/22) shows that claims that a controller’s unique liquidity needs create a conflict of interest occasionally get some traction in the Chancery Court.
This Debevoise memo reviews the Manti Holdings decision and other relevant Delaware case law on “liquidity conflicts” and discusses some of the alternative ways of managing the legal risks they create. This excerpt notes that either the MFW process or a special committee are often used when a controller stands on both sides of a transaction, but says that approach shouldn’t be necessary for most cases involving potential liquidity conflicts:
A conflicted controller can avoid the exacting standard of entire fairness by requiring a transaction to be approved both by a special committee of independent directors and by holders of a majority of the stock held by the company’s unaffiliated stockholders. Should a private equity investor controlling a company with minority public stockholders use a special committee — whether or not coupled with a majority-of-the-minority approval condition — in order to avoid liquidity conflict claims? In most cases, probably not. Absent other conflicts, the mere desire of a controller to achieve liquidity through an entire company sale generally would not present a level of litigation risk that would lead most controllers to cede control of a sale process to a special committee.
The memo notes that because the controlling stockholder in Manti Holdings held preferred stock instead of common stock, establishing a special committee to oversee that transaction may have provided meaningful protection. While that step may not be necessary for “garden variety” liquidity conflicts, the memo stresses that private equity sponsors and other controllers should be prepared to justify the reasonableness of the sale process chosen and avoid suggesting that the timing or manner of the sale is intended to confer a benefit on them that isn’t shared by other stockholders.
– John Jenkins