Saturday, December 28, 2019
I’ve previously blogged about – and written an essay about – how one of the knock-on effects of Corwin and MFW is to increase the distance between the treatment of controlling shareholder transactions, and other transactions, under Delaware law. As a result, the outcome of many a motion to dismiss turns solely on the presence or absence of a controlling shareholder – which puts increasing pressure on the definition of control in the first place. In particular, I’ve argued, courts uncomfortable with Corwin’s Draconian effects may be tempted to expand the definition of control in order to avoid early dismissals of cases that smack of unfairness.
The latest example of the genre comes by way of Vice Chancellor McCormick’s ruling on the motion to dismiss in Garfield v. BlackRock Mortgage Ventures et al. There, an enterprise organized as an “Up-C” sought to transform itself into an ordinary corporation, largely for the benefit of the two founding investors, BlackRock and HC Partners, as well as several directors and corporate officers. The question was whether the transaction was fair to the public stockholders, who overwhelmingly voted in favor of the deal. If BlackRock and HC Partners were not deemed to be controllers, the stockholder vote would cleanse the deal under Corwin and the case would be dismissed; if they were, the court would be permitted to substantively examine the transaction’s fairness.
Together, BlackRock and HC Partners controlled 46.1% of the vote, had Board representation, and had blocking rights; thus, the court easily found that if they acted together, they had control. The critical question was whether they had, in fact, agreed to act in concert, or whether they simply had concurrent, but independent, interests in the transaction. For these sorts of inquiries, the standard on which Delaware courts have settled is that to constitute a group, the putative controllers must be “connected in some legally significant way—such as by contract, common ownership, agreement, or other arrangement—to work together toward a shared goal.”
To determine whether this standard was met, McCormick looked for both transaction-specific facts suggestive of an agreement, as well as historical facts indicting that the defendants had agreed to coordinate in the past. Here, BlackRock and HC Partners’s long history of coordinated involvement with the company, coupled with their critical roles in approving the reorganization, created an inference of concerted action. As a result, the plaintiff had plausibly alleged the presence of a controlling group, and Corwin did not apply. Motion to dismiss denied.
So, there are a couple of things that interest me here.
First, it’s another example of “controller-creep.” The cases on which McCormick relied, Sheldon v. Pinto, 2019 WL 4892348 (Del. Oct. 4, 2019) and In re Hansen Medical Shareholders Litigation, 2018 WL 3025525 (Del. Ch. June 18, 2018), also identified “historical” ties as a factor to consider when inferring the presence of an agreement among putative members of a control group, but in those cases, the courts demanded that plaintiffs identify multiple investments in multiple companies – and refused to infer an agreement without them. Here, by contrast, McCormick found a history just due to the defendants’ investment in this single company.
Second, there are many areas of law where the presence of an agreement among parties, rather than simply concurrent self-interest, is critical (13D filings, antitrust law, RICO), and courts therefore have to closely examine the defendants’ behavior to see if such an agreement can be inferred. There seems to be little cross-pollination in the caselaw, however (though in Hansen, one “historical” factor used to infer the existence of an agreement was a 13D filing from a previous venture), and to be honest, that’s how it should be – there are different policies at play in different areas of law, not to mention different legal standards on a motion to dismiss, and it makes sense courts would therefore approach the analyses differently. That said, in the Garfield briefing, I detect efforts by the BlackRock defendants in particular to import antitrust concepts into the controlling shareholder inquiry, via the suggestion that agreements can only be inferred if there’s evidence that the parties sacrificed their immediate self-interest in service of a larger goal. Correctly, I think, McCormick chose not to pursue that argument.
Third, though, I get back to my problem with this entire line of precedent, which is well-illustrated by this case. We’re talking about a transaction structured to benefit a small number of shareholders with outsized voting power and management control; BlackRock and HC Partners had veto rights and were intimately involved in the planning stage even before the presentation to the Board. If the goal is to protect the public stockholders, why on earth should it matter whether these two formally agreed to act together? Whether they did or they didn’t wouldn’t make the transaction any less favorable to them, or any less coercive to the public stockholders. And that’s because control exists on a spectrum, not as an on/off switch, and two large investors with concurrent interests, board representation, and 46.1% of the voting power are just as threatening to the public stockholders, and exert just as much influence, whether they’ve formally agreed to act together or not. Plus, recall that the whole (purported) reason controlling shareholder transactions cannot be cleansed by a shareholder vote is that we presume shareholders are afraid to buck a controller. Shareholders can’t be intimidated by a secret agreement they know nothing about; if we were truly serious about inquiring into shareholder coercion, we’d be asking about shareholder perceptions of an agreement, not whether there actually was one. So what we’re seeing, again, is how the “controlling shareholder” legal analysis imposed by Corwin/MFW is often divorced from the underlying business reality, which ultimately leads courts down a garden path of irrelevance.