Saturday, February 15, 2020
Back to a subject near and dear to my heart: The increased pressure on the definition of “controlling stockholder” occasioned by Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) and Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”). I’ve posted about this on several prior occasions, and written an essay on the subject, so I would be remiss if I didn’t discuss VC Laster’s new ruling in Voigt v. Metcalf. The facts, as taken from the opinion, are these:
CD&R was a 34.7% blockholder of a publicly-traded corporation called NCI. In earlier years, CD&R had held as much as 68%. CD&R had a stockholder agreement that, among other things, guaranteed it a certain number of board seats – but also guaranteed a certain number of seats for the unaffiliated stockholders – guaranteed that its nominees would have seats on key committees, and gave it blocking/consent rights for various board actions, though none were triggered in this case.
In early 2018, three things happened nearly simultaneously: Metcalf, one of the independent/unaffiliated directors of NCI, was elevated to Chair; CD&R acquired a majority stake in a company called New Ply Gem; and Metcalf proposed that NCI acquire New Ply Gem. To negotiate the deal, Metcalf met with certain NCI directors who were also CD&R representatives/designees.
Eventually, NCI created a Special Committee to evaluate the transaction, and hired Evercore. Well, actually Metcalf hired Evercore before the committee was even formed, and the Committee was told that Evercore had no conflicts – which was untrue, because Evercore was currently working for another CD&R portfolio company. The Committee decided to keep NCI’s counsel, Wachtell.
Evercore recommended that New Ply Gem be acquired with NCI stock valued, post-deal, at roughly 1/3 of NCI’s total equity. This valuation was based on CD&R’s own valuation when it acquired New Ply Gem. CD&R – via the NCI board members – insisted on closer to a 50/50 split. The Committee agreed. The Committee asked for a majority-of-minority voting condition; CD&R refused. When the deal was announced, NCI’s stock price fell, and of the unaffiliated stockholders, only 55% voted in favor.
After the transaction closed, an NCI stockholder brought a derivative lawsuit and, for our purposes, the critical question was whether CD&R was a controlling shareholder. If not, the deal was likely cleansed by the shareholder vote – and even if there were disclosure deficiencies (spoiler: there were), plaintiff would have to establish that the Special Committee was interested/dependent on CD&R to succeed on his claim. But if CD&R was a controlling shareholder, the deal was subject to entire fairness review.
VC Laster concluded that CD&R was a controlling shareholder, and refused to dismiss.
So, what’s notable here?
[More under the jump]
First, since the claims were brought derivatively, technically, they were subject to the demand requirement.* Laster, however, found that defendants had waived their right to argue that demand was not excused. He ultimately concluded that a majority of the board was conflicted anyway, so it probably didn’t matter much, but looking at the briefs, it seems like this was a case of two sets of defense attorneys getting their wires crossed about which parties were responsible for which arguments, ultimately resulting in no one making a full-throated pitch for dismissal on 23.1 grounds. So, you know, that’s a precautionary tale about working with co-counsel.
Second, Laster was very careful to say that he was inferring CD&R’s control from a holistic consideration of the facts, and that of course his analysis was all in the context of the plaintiff-favorable “reasonably conceivable” standard.
That said, what Laster found particularly relevant:
Of a 12 member board, 4 were CD&R partners or consultants. Two more were CD&R designees, and though CD&R tried to argue they were independent, Laster was not having it. Partly, this was because of certain admissions in NCI’s SEC filings, but more interestingly, it was because they had served in various (lucrative) capacities at other CD&R portfolio companies for decades. In other words, they were pretty classic examples of the phenomenon Da Lin describes in her article, Beyond Beholden – namely, that some large shareholders are in the habit of doling out benefits to a repeating network of friendly directors, and that fact should be taken into account by courts adjudicating whether such directors are “independent” of the shareholder.
But that’s not all. Metcalf, who proposed the deal in the first place, was on the Special Committee, and was deemed not independent because he was expecting to become – and did become – Chair and CEO of NCI post-transaction. The then-current NCI CEO was deemed not independent because he was first hired when CD&R had hard control. So that’s 8 out of 12.
Next, Laster spent a surprising amount of time explaining how, with a 34.7% stake, CD&R could functionally control the outcome of shareholder votes, given the well-recognized fact that roughly 20% of all public company shares are never voted at all. He even cited Delaware’s own business combination statute for the proposition that, in other contexts, even a 20% stake might create a presumption of control. That interests me because there are Delaware cases where stakes over 30 to over 40 percent were deemed not controlling – one of which was decided very recently. See, e.g., In re Rouse Props., 2018 WL 1226015 (Del. Ch. Mar. 9, 2018); In re W. Nat. Corp. S’holders Litig., 2000 WL 710192 (Del. Ch. May 22, 2000); Zlotnick v. Newell Cos., 1984 WL 8242 (Del. Ch. July 30, 1984). Rouse was a very different case (it had all of the hard bargaining absent here, see below), but the sheer time Laster took with this point suggests that he thinks judges aren’t taking large blocks seriously enough.
Finally, Laster highlighted other indicia of CD&R’s control, such as its right to committee representation (especially nominating committee representation).
What Laster did not mention as part of his actual formal legal reasoning – though it was conveyed in the statement of facts – was how unbelievably sketchy this entire transaction was from soup to nuts. Large blockholder, suspiciously propitious timing, valuation shenanigans, an abysmal market/shareholder reaction. CD&R’s prior, internally low valuation of New Ply Gem was technically disclosed in the proxy statement distributed to shareholders, but only in the most obscure way possible – which itself suggests consciousness of wrongdoing. The whole transaction reads like a law school issue-spotter of governance failures. Of course Laster was going to conclude that CD&R was a controller if he couldn’t get at the transaction in any other way. CD&R’s refusal to agree to an MOM condition alone sent an ominous message; unaffiliated shareholders could be forgiven for interpreting it as “Be afraid. Be very afraid.”
But imagine if, for example, there was a truly independent special committee and hard bargaining and realistic valuations and whatnot. In In re Tesla Motors Stockholder Litigation, VC Slights held that that kind of blockholder self-disablement – even in the absence of the full suite of MFW protections – might be enough to deem someone not a controller in the first place. And it’s possible Laster would have been less motivated to find control if that had been the scenario that confronted him.
My point being, once again, Corwin drives Chancery judges to seek solace in determinations of control.
This is not to say that the definition of control is infinitely elastic. There are limits, which the plaintiffs discovered in, for example, In re Essendant, Inc. Stockholder Litigation. But courts are using the leeway available to them – and there’s a lot of it – as a means of applying a more exacting scrutiny to the transactions that raise red flags.
*The parties jousted over whether the claims were both direct and derivative under Gentile, but because Laster held that defendants’ 23.1 arguments were waived, he didn’t need to reach that issue.