Saturday, January 2, 2021
I’ve previously written about Shari Redstone and the controversies surrounding Viacom and CBS; this week, VC Slights kindly gave me something new to blog about when he denied defendants’ motion to dismiss shareholder claims associated with the Viacom/CBS merger.
The CliffsNotes version is that due to a dual-class voting structure, Shari Redstone was the controlling shareholder of CBS and Viacom, and for several years fought to combine the two companies. Her dreams were finally realized in 2019 when the two merged in a stock-for-stock deal. Former Viacom shareholders sued, alleging that this was a transaction in which a controlling stockholder – Redstone – stood on both sides, and that the deal sold out the Viacom shareholders to benefit CBS and Redstone.
Normally, of course, deals in which a controlling stockholder has an interest are subject to entire fairness scrutiny unless they are cleansed in the manner prescribed by Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). Notwithstanding the failure to employ those protections here, the defendants creatively claimed that business judgment review was appropriate – and moved to dismiss on that basis – arguing that mere presence on both sides does not trigger heightened scrutiny; instead, plaintiffs must additionally show that the controller received a nonratable benefit, which did not happen in the CBS/Viacom merger.
To me, that’s kind of redundant; by definition, standing on both sides of a transaction means that the controller received something not available to the minority stockholders. In this case, Redstone was able to trade her CBS stock for shares in the combined entity – a benefit that Viacom stockholders did not share. (Well, okay, probably some Viacom stockholders did, but that’s a whole ‘nother issue I’ve talked about pretty endlessly).
VC Slights, however, was unsatisfied with leaving things there, perhaps because it begs the question why Redstone would have favored CBS over Viacom in the exchange ratio. And the answer to that, according to the plaintiffs, was because Redstone wanted Robert Bakish at Viacom to head the combined entity, and a favorable-to-CBS exchange ratio was the price that the CBS board demanded for installing him. Normally, it might be reasonable to trade merger consideration for a particular governance arrangement, so plaintiffs further argued that this arrangement was unfair to the Viacom stockholders because Bakish wasn’t worth the price. Redstone wanted him in place for personal reasons (to cement her control by installing an ally).
In any event, all of this left Slights with the question whether (1) standing on both sides is enough to trigger fairness scrutiny absent a nonratable benefit to the controller, and (2) if not, did plaintiffs allege enough of one?
What’s interesting here?
First, though Slights chose not to decide whether entire fairness must always apply when a controller stands on both sides, in discussing the question, he had something of an intriguing footnote. He wrote:
I note that Viacom and CBS’s dual-class structures, whereby NAI possessed more than 80% of the voting power but faced only 10% of the economic risk in both companies, commends Plaintiffs’ “mere presence” argument for careful consideration in this case. See David T. White, Delaware’s Role in Handling the Rise of Dual-, Multi-, and Zero-Class Voting Structures, 45 Del. J. Corp. L. 141, 153–54 (2020) (positing that in dual-class structures, “the owners of the majority voting rights in these companies are less concerned when riskier moves fail as compared to their counterparts at ‘one share-one vote’ corporations”); Lucian A. Bebchuk & Kobi Kastiel, The Perils of Small-Minority Controllers, 107 Geo. L.J. 1453, 1466 (2019) (observing that “small-minority controllers are insulated from market disciplinary forces [in dual-class companies] and thus lack incentives generated by the threat of replacement, which would mitigate the risk that they will act in ways that are contrary to the interests of other public investors”); id. (“[D]ualclass structures with small-minority controllers generate significant governance risks because they feature a unique absence of incentive alignment.”).
As we all know, dual class share structures are increasingly popular, and concerns have been raised that they present a challenge to Delaware corporate doctrine, which assumes that stockholders have economic incentives proportional to their interests and that a functioning market for corporate control justifies a deferential judicial stance. I could of course be overreading the footnote, but to me it suggests a hint of a step toward Delaware developing differential scrutiny for disputes involving dual-class shares, especially since the Note he cites by David White argues precisely that the business judgment rule is inapposite in dual-class cases.
Second, after concluding that Redstone’s personal interest in consolidating her control was a sufficient nonratable benefit justifying entire fairness scrutiny, he further held that plaintiffs had stated a claim against the controller for breach of fiduciary duty. But that left the question whether plaintiffs had also stated a claim against the directors on Viacom’s special committee for breaching their duties by, essentially, bowing to Redstone’s demands.
Now the interesting thing here is that plaintiffs did not allege that the Viacom directors were interested in the transaction themselves; the entire basis for the allegations of disloyalty arose from their obedience to Redstone.
Thus the question: Assuming plaintiffs have alleged facts to suggest a transaction was unfair due to a conflict, can they state a non-exculpated claim for breach of fiduciary duty against disinterested directors who were involved with that transaction, solely due to their dependence on the person with the conflict?
To answer that question, Slights quoted In re Cornerstone Therapeutics, Inc. Stockholder Litigation, 115 A.3d 1173 (Del. 2015):
To state “a non-exculpated claim for breach of fiduciary duty against an independent director protected by an exculpatory charter provision,” Plaintiffs must allege “facts supporting a rational inference that the director harbored self-interest adverse to the stockholders’ interests, acted to advance the self-interest of an interested party from whom they could not be presumed to act independently, or acted in bad faith.”
Cornerstone did say that, ‘tis true, but it still begs the question whether mere lack of independence is enough, or whether something more is required. (VC Glasscock asked that question in connection with a dispute over Oracle’s acquisition of NetSuite, and sought additional briefing on the matter. Which was never filed; the plaintiffs voluntarily dismissed their claims against the relevant defendants.)
Because here’s the thing. There’s dependence, and there’s dependence. There’s director dependence that comes from essentially agreeing to work for the controller rather than to work for the corporation, and there’s director dependence that comes from, you know, being unconsciously biased to favor a friend. That’s particularly true today, since Leo Strine worked so hard to expand the concept of director dependence to include “mutual affiliations” that would make it “difficult to assess [a person’s] conduct without pondering his own association with [that person],” In re Oracle Corp Deriv. Litig., 824 A.2d 917 (Del. Ch. 2003), and “relationships [that] give rise to human motivations compromising the participants’ ability to act impartially toward each other,” Sandys v. Pincus, 152 A.3d 124 (Del. 2016). Acquiescing to a controller’s demands comes very close to a “conscious disregard” for the director’s duties, or an intent to “act with a purpose other than that of advancing the best interests of the corporation.” Stone v. Ritter, 911 A.2d 362 (Del. 2006). Simple lack of objectivity, though, is much more like a good faith failure to recognize the flaws in one’s own judgment.
Which is why it is not obvious that there’s a blanket rule that dependence, alone, states a claim for disloyalty.
That said, Slights elided this issue, which he could do successfully because, although he framed his analysis in terms of director “dependence,” he actually found that plaintiffs had alleged a more serious kind of dependence – a “controlled mindset,” whereby they simply worked to advance Redstone’s goals. And that, coupled with other allegations about their relationship to Redstone, was enough to “plead reasonably conceivable breaches of the duty of loyalty.”
Third, the final interesting data point in Slights’s examination of director independence had to do with the legal significance of the directors’ fear that Redstone would fire them if they failed to do her bidding. Now, the doctrine is sort of confused when it comes to directors’ fear of being removed by a controller – in the context of derivative lawsuits, it’s not grounds for a finding of dependence unless the directors have a personal need to remain on the job; in the context of cleansing a controller conflict, we assume generally that directors fear removal.
Here, though, the question was whether fear of removal was enough to create dependence such that it suggested disloyalty on the directors’ part – which is a whole ‘nother question (one which, I would think, might actually raise the bar for a finding of dependence). And to answer that, Slights said that while he would not generally assume directors are dependent simply because they serve at the pleasure of the controller, it was not necessary for the plaintiffs to allege that these directors had an especial need for their positions in light of Redstone’s specific history of threatening to remove board members at Viacom and CBS who bucked her authority. The fact that they labored under that realized threat created an inference of dependence.
So takeaway here? The definition of dependence and its legal significance shifts across contexts – and depending on how the dual-class case law shapes up, the same may turn out to be true of control.