Stockholder Approval and the BJR in the Absence of a Controlling Shareholder

I am preparing to teach the doctrine on controlling shareholders in my corporations class tomorrow, and found the recent Delaware opinions on non-controlling shareholder cleansing votes and the BJR to be helpful illustrations of the law in this area.

In summer 2016, the Delaware Court of Chancery dismissed two post-closing actions alleging a breach of fiduciary duty where there was no controlling shareholder in the public companies, where the stockholder cleaning vote was fully informed, and applied the 2015 Corwin business judgment rule standard.  The cases are City of Miami General Employees’ & Sanitation Employees’ Retirement Trust v. Comstock, C.A. No. 9980-CB,  (Del. Ch. Aug. 24, 2016) (Bouchard, C.) and Larkin v. Shah, C.A. No. 10918-VCS, (Del. Ch. Aug. 25, 2016) (Slights, V.C.), both of which relied upon  Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304 (Del. 2015).  (Fellow BLPB blogger Ann Lipton has written about Corwin here).

The Larkin case clarified that Corwin applies to duty of loyalty claims and will be subject to the deferential business judgment rule in post-closing actions challenging non-controller transactions where informed stockholders have approved the transaction.   The Larkin opinion states that:

(1) when disinterested, fully informed, uncoerced stockholders approve a transaction absent a looming conflicted controller, the irrebuttable business judgment rule applies; (2) there was no looming conflicted controller in this case; and (3) the challenged merger was properly approved by disinterested, uncoerced Auspex stockholders. Under the circumstances, the business judgment rule, irrebuttable in this context, applies. ....The standard of review that guides the court’s determination of whether those duties have been violated defaults to a deferential standard, the business judgment rule, which directs the court to presume the board of directors “acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company.” In circumstances where the business judgment rule applies, Delaware courts will not overturn a board’s decision unless that decision 'cannot be attributed to any rational business purpose.' This broadly permissive standard reflects Delaware’s traditional reluctance to second-guess the business judgment of disinterested fiduciaries absent some independent cause for doubt.  Larkin at 21-22 (internal citations omitted).

Two-sided controller transactions (a freeze out merger where a controlling shareholder stands on both sides of the transaction) is covered by the 2014 Kahn v. M & F Worldwide Corp., 88 A.3d 635(Del. 2014) case, which I summarized in an earlier BLPB post here.

To refresh our readers, the controlling shareholder test is a stockholder who owns a majority of stock. Additionally, a stockholder may qualify as a controller if:

Under Delaware law, a stockholder owning less than half of a company’s outstanding shares may nonetheless be deemed a controller where 'the stockholder can exercise actual control over the corporation’s board.'This “actual control” test requires the court to undertake an analysis of whether, despite owning a minority of shares, the alleged controller wields “such formidable voting and managerial power that, as a practical matter, [it is] no differently situated than if [it] had majority voting control.'A controlling stockholder can exist as a sole actor or a control block of “shareholders, each of whom individually cannot exert control over the corporation . . . [but who] are connected in some legally significant way—e.g., by contract, common ownership agreement, or other arrangement—to work together toward a shared goal.' Larkin at 33-34 (internal citations omitted).

Excellent commentary on theLarkin and Comstock cases and their practical implications can be found on the Harvard Law School Forum on Corporate Governance and Financial Regulation, available here.

-Anne Tucker