Saturday, May 15, 2021
Vice Chancellor Zurn just issued a monster, 213-page opinion sustaining a complaint alleging that the Board of Pattern Energy breached its fiduciary duties when selling the company. At 213 pages, there’s a lot to talk about, but I actually am going to focus on a couple of specific points that happen to intersect with a lot of what I blog about here.
The set up: Pattern Energy was created by a private equity firm, Riverstone, to operate energy projects owned by other Riverstone entities. At one time, Riverstone indirectly owned a controlling stake in Pattern, but by the time of the events of the complaint, it had shed its interest. It did continue to exert influence, though. First, Pattern had been formed to operate other Riverstone projects, and continued to do so, mainly though its relationship with another company called Developer 2, which was majority-owned by Riverstone. Second, Pattern owned a stake in Developer 2, but was prohibited from selling that stake – including through a merger – without Riverstone’s consent, which functionally gave Riverstone approval power over Pattern mergers. Third, most of Pattern’s officers, including its CEO, were Riverstone affiliates and partners in various ways, including by occupying present or past managerial roles with Developer 2. Fourth, two of Pattern’s directors were Riverstone people – its CEO, and a Riverstone manager who had been appointed to Pattern’s board back when Riverstone had hard control.
According to the complaint, Pattern began contemplating a merger, and because of its close ties to Riverstone and especially Developer 2, Riverstone wanted to make sure that any merger would preserve Riverstone’s influence and Pattern’s relationship with Developer 2. Therefore, Riverstone preferred a financial buyer who would maintain Riverstone’s role with the companies, and was opposed to a strategic acquirer, Brookfield, who would pay more for Pattern but would either also absorb Developer 2 or disentangle it from Pattern. The plaintiff alleged, and Zurn accepted, that Pattern’s Board favored the financial buyer over Brookfield, largely to protect Riverstone, in violation of its duties to maximize wealth for Pattern’s stockholders. Zurn also sustained certain claims against Pattern’s officers, and aiding-and-abetting claims against Riverstone.
So here’s what I find most interesting....
(More under the jump)
First, the plaintiff alleged that Riverstone, working with Pattern’s officers, functionally formed a control group, and therefore the deal had to be evaluated under the entire fairness standard absent cleansing under Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).
Readers of this blog are by now well aware that the issue of who counts as a controller, and when Kahn cleansing standards, rather than Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) standards, are appropriate, is one of my continuing hobbyhorses. I’ve blogged about it several times (most recently in this post, which has links to earlier ones), and I wrote an essay addressing the problem, After Corwin: Down the Controlling Shareholder Rabbit Hole. Zurn devoted several pages to a discussion of how one becomes a controller, holding that even though Riverstone did not own any stock in Pattern, directly or indirectly, it was possible that it attained fiduciary status due to its other mechanisms of control.
The most interesting of these mechanisms was Riverstone’s consent right, which nominally allowed it to block a merger by Pattern with a third party. As it turned out, Pattern’s Special Committee was counseled that the consent right was relatively flimsy, and could be evaded with the right merger structure. Brookfield agreed, and at first proposed precisely such a structure, so as to avoid having to get Riverstone’s buy-in. But Pattern’s CEO – a Riverstone guy – insisted that the consent right was impregnable, and the Special Committee proceeded on that assumption without pushback. So the Special Committee functionally deferred to Riverstone when it didn’t necessarily have to do so.
What’s also interesting here is that Pattern, controlled by Riverstone people and created to do business with Riverstone affiliates, looks a lot like the company at the center of Corwin. That company, too, was created by a private equity firm (KKR) to do business with it, and KKR’s people ran the company on a day-to-day basis, but KKR did not own much equity and had not elected the directors. The Delaware Supreme Court held that KKR was not a controlling shareholder.
Zurn did not draw any comparisons to Corwin when she concluded that Riverstone might have been a controller of Pattern, despite the similarity in the set ups. Why is that? Well, at least one thing that leaps out is how poorly the conflicts between Pattern and Riverstone were managed throughout the sales process. In addition to the Special Committee deferring to Riverstone’s consent right – despite being apprised of its fragility – the Special Committee allowed a Riverstone-affiliated Pattern director to sit in on its deliberations, and allowed the Riverstone-affiliated CEO to manage negotiations. There were no comparable allegations in Corwin, and controller status can be tested either by control over operations generally, or by control over the specific transaction at issue. Seen in that light, Riverstone’s affiliation with Pattern and its willingness to use that affiliation to influence Pattern’s behavior on Pattern’s side may have been what made the difference.
Anyway, Zurn did not in fact determine that Riverstone was a controller – she simply held it was possible, and reserved judgment until a factual record could be developed. Instead, she sustained the complaint with Revlon enhanced scrutiny, and rejected the defendants’ argument that the deal had been cleansed by the shareholder vote under Corwin.
Which gets to the second aspect of the case I want to talk about. The plaintiff alleged, and Zurn agreed, that the proxy statement had serious deficiencies. Among other things, it did not describe some of the conflicts that pervaded the negotiating process, did not disclose that the Special Committee had been advised that the consent right could be evaded, and did not fully communicate the superiority of Brookfield’s offer. Corwin cleansing depends on a fully-informed shareholder vote, so these deficiencies undermined any Corwin defense, right?
Zurn did reject the Corwin defense, but not because of deficiencies in the proxy statement – deficiencies that she agreed constituted an independent breach of duty.
That suggests motivation to reach an issue. So what interests me is the nature of the issue she wanted to reach.
Well, it turns out that Pattern had two blockholders who voted in favor of the transaction. One, PSP, held 9.9% of Pattern’s stock, and also was invested in certain Riverstone funds that themselves were invested in Developer 2. In other words, PSP had an interest both in Pattern, and in Riverstone/Developer 2.
The other blockholder was a company called CBRE. In the middle of the ongoing Pattern merger negotiations, Pattern’s CEO – remember, a Riverstone guy – insisted that the company right away issue new preferred shares to raise capital for new projects. These preferred shares would pay a higher dividend rate than Pattern would have had to pay in interest had it chosen to issue debt. The preferred shareholder would get to roll over its shares to any post-merger entity at a higher dividend rate. And, crucially, the preferred shareholder would be contractually obligated to vote its shares in favor of any merger proposal. CBRE was the lucky buyer.
The plaintiff pointed out that if you treated PSP and CBRE as interested parties, then fewer than 50% of the disinterested shares favored the merger – not enough to cleanse under Corwin.
Zurn agreed with the plaintiff with respect to CBRE. Because CBRE was contractually obligated to vote its shares in favor of the deal – and because it could not have known the details of the deal when bought the preferred, since no final deal had been reached – its vote was uninformed. And, the contractual obligation made its vote coerced. And, CBRE’s ability to participate in the post-merger entity made it an interested party. Taking CBRE out of the equation reduced the vote in favor of the merger to 47.3%, which meant, no cleansing.
Having concluded that, Zurn declined to reach the question whether PSP’s votes were also interested.
So, my take: Zurn thought the preferred share issuance was a particularly egregious attempt by Pattern’s CEO to force a deal through. Indeed, though she didn’t say so explicitly, the generous terms on which the shares were issued carried more than a whiff a vote-buying. As Zurn put it, “It is reasonably conceivable that the preferred stock issuance, backed by Garland and passively observed by the Special Committee, was in furtherance of jamming though the Board-approved Merger, which was not the best deal for stockholders.” Point being, I think Zurn could have rejected the Corwin defense on the grounds of the deficient proxy, but she wanted to comment on the preferred share issuance, precisely in order to condemn it.
That said, while it is not that uncommon for companies to issue preferred shares to a friendly party in order to consummate (or avoid) a transaction, it’s still not an ordinary kind of thing.
What is far more mundane is the kind of conflict faced by PSP, where it happened to passively hold shares on what was functionally both sides of a deal. Which gets to the other of my hobbyhorses: cross-ownership. Suffice to say, I’ve blogged about this a million times as well, and I talk extensively about its implications for mergers in Shareholder Divorce Court, but the critical point here is it happens all the time because the large mutual fund complexes hold shares in everything, including companies that eventually merge. But Delaware has not refined its definition of “interested” sufficiently to settle how these investors should be treated. In fact, in In re Tesla Motors Stockholder Litig., 2018 WL 1560293 (Del. Ch. Mar. 28, 2018), Chancellor Slights expressly declined to decide whether mutual funds that owned shares in both Tesla and SolarCity were interested parties for the purpose of cleansing the Tesla/SolarCity merger.
Zurn, as well, did not want to go there – and she didn’t. So the punchline here is, she went out of her way to decide what she wanted to decide – the impropriety of the CBRE/preferred share issuance – but obtrusively did not dive into the much more fraught territory of passive cross-ownership.
And, those are my big takeaways.