Saturday, July 22, 2023

The One Where They Castrated Calves Together

John Malone and Gregory Maffei are repeat players before the Delaware courts.  They often occupy complementary positions within Delaware companies, and are frequently accused of abusing their combined positions to muscle through interested transactions.  Here’s a footnote from the complaint in Atallah v. Malone, which is the subject of today’s blog post:

Malone and Maffei have been sued numerous other times for engaging in self-dealing to the detriment of public stockholders. See, e.g., New Orleans Empls. Ret. Sys. v. The DIRECTV Group, Inc., C.A. No. 4606-VCP (Del. Ch. 2009) (Malone accused of orchestrating transaction, with Maffei’s approval, to obtain supervoting shares dilutive to the minority stockholders and receiving disproportionate tax benefits); Blackthorn Partners LP vs John C Malone, et al., C.A. No. 5260-CS (Del. Ch. 2010) (Malone accused of receiving premium for high-vote shares, with Maffei’s approval, that public shareholders did not receive, with class ultimately receiving $10 million settlement); In re Sirius XM S’holder Litig., Consol. C.A. No. 7800-CS (Del. Ch. 2012) (Maffei and rest of Board accused of failing to employ anti-takeover measures thus allowing Malone affiliate to improperly obtain majority control); In re Starz S’holder Litig., C.A. No. 12584-VCG (Del. Ch. 2016) (Malone accused of structuring transaction, with Maffei’s approval, such that he received different and more valuable consideration than public stockholders regardless of stockholder vote); Tornetta vs. Gregory B. Maffei, et al., C.A. No. 2019-0649-KSJM (Del. Ch.) (Board of directors including Maffei accused of ignoring standstill agreements and relying on Malone-affiliated banker to steer sale of company to Malone affiliate rather than sell at higher value to third party); Vladimir Fishel v. Liberty Media Corp., et al., Docket No. 2021-0820-KSJM (Del. Ch.) (Board of directors including Maffei accused of using company coffers to help Malone affiliate squeeze out minority stockholders).

Not included on this list, I don’t think, is Sciabacucchi v. Liberty Broadband, 2023 WL 4157103 (Del. Ch. June 22, 2023), in which Malone and Maffei settled claims involving related party transactions at Charter Communications,

Maffei has been the subject of so many shareholder lawsuits that he’s now seeking to reincorporate two of his companies from Delaware to Nevada, apparently for the explicit purpose of engaging in interested transactions with less oversight – which reincorporation is itself the subject of another shareholder lawsuit.

So that’s the background for Atallah v. Malone, where VC Glasscock found that derivative claims were properly pled against Malone and Maffei for a conflicted transaction, and refused to dismiss the complaint.

The set up: Qurate is a publicly traded company, of which Malone held high vote shares.  These were not by themselves enough to confer hard control at the 50% level, but were controlling enough that he had – and was compensated for – a call right held by Qurate.  If a third party were to offer for his high vote shares, and he was willing to accept, Qurate could call the shares for the lower of the third party offer, or a price equal to a 10% premium over the common, publicly traded shares.

Maffei was Executive Chair at Qurate, and also had an employment agreement to the effect that if Qurate changed control, he’d be entitled to resign from Qurate and win change in control benefits.

Given the close relationship between Malone and Maffei, then, as Matt Levine might put it, there was an opportunity for a Good Trade.

Maffei could “offer” to buy Malone’s shares; that would trigger the call right by Qurate, which would buy Malone’s shares at a premium above market.  Once Malone no longer held high vote shares, that would trigger a change in control at Qurate, which would entitle Maffei to severance.

And so that’s exactly what they did.  Except, of course, neither wanted to really leave Qurate, so Malone accepted for his high vote shares payment in common stock instead of cash, at a 10% premium to market price.

Meanwhile, Maffei said, “Yes, I could resign and take my severance, but I would be willing to stay on for a renegotiated compensation package” – which Qurate did, which included granting him high vote shares.

I haven’t done the math regarding the exact number of shares involved, but in many ways, the transaction appears to be designed to transfer Malone’s high vote shares to Maffei, while simultaneously giving Malone a premium and possibly Maffei a bit of a premium in stock awards, all out of Qurate’s pocket.

So of course, shareholders sued, claiming this entire series of transactions was undertaken by a controlling shareholder group – Malone and Maffei coordinating – to benefit them both.

What’s interesting here?

[More under the cut]

The thing that’s most interesting is the role that Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) is playing in the opinion without any actual reference to it.  And that’s interesting because the Delaware Supreme Court is now about to consider the scope of MFW

But before I go there, I must go back.

Qurate had a 10 member board.  Of those 10 members, 7 formed an independent committee to address whether Maffei’s offer did in fact trigger the call right – there was a very good argument it did not – and negotiate terms with Malone if it did.   Of those 7, 3 formed a compensation committee to negotiate the effects on Maffei’s employment contract, if a call right had been triggered.

Which means.

For the purposes of demand excusal, in this derivative action, the question was whether the 10 member board was conflicted.

But for the purposes of the underlying transactions, and whether a conflicted transaction had been cleansed, the issue concerned the independence of the 7 member independent committee, and the 3 member compensation committee.

Starting with demand excusal:

Of the 10 member board, 2 were financially interested (Malone and Maffei).  A third was Malone’s son.  That left 7 members – the same 7 who formed the independent committee to handle the call right.

Of those 7, the theme in the plaintiffs’ argument was that 4 of them owed “generational wealth” to Malone, because they were associated with companies that Malone had bought out or had close relationships with.

I will spare you the details – suffice to say, it’s clear that’s exactly what Malone does, identify allies on whom he has conferred millions in various deals and staffs them as directors in his other companies.

Yet, Glasscock found that despite these relationships, dependence for Delaware purposes was only shown for 2 of the 4 board members alleged to have financial ties to Malone.  One of those 2 had a close enough relationship with Malone that

the two men have purportedly engaged in activities together ranging from grilling steaks, to riding all-terrain vehicles, to castrating calves.

The Plaintiffs stress the latter activity without explaining its significance here. Presumably, Romrell and Malone’s neutering of bull calves is a significant male bonding experience, for the subjects of this sentence if not for the objects.

Let’s just say that as classroom examples of lack of independence go, I think the plane-sharing of Sandys v. Pincus is about to be eclipsed.


I could go on about the poverty of Delaware standards for identifying dependence, if incredibly lucrative relationships across companies are still not deemed sufficient, but castrating calves is.  Let’s skip it: Plaintiffs were able to show 5 out of 10 directors on the whole board were either Malone and Maffei, blood relatives of Malone and Maffei, or financially beholden to Malone and Maffei.  Five of the whole board were conflicted.

Fine.  The 10 member board is not majority independent, and demand is excused.

But there still needs to be a claim regarding the underlying transactions – the call right with Malone, deemed triggered by a 7 member committee, and the compensation deal with Maffei, approved by a 3 member committee.  

The plaintiffs alleged that Malone, and Maffei, together, were controlling shareholders.

Why does this matter?  Both were directors of Qurate, which means both had fiduciary duties to Qurate, regardless of whether they were controllers.

Glasscock does not in fact say in his opinion.  There’s no explanation of why control matters.  But as far as I can tell, the reason it matters is for cleansing.  The deal with Malone – whether the call right had been triggered by Maffei’s offer, and whether it would be payable in common stock – was agreed to by the 7 member committee of the Qurate board.  The deal with Maffei – renegotiate his compensation given the change of control – was agreed to by a 3 member committee of the Qurate board. 

The court agreed that both committees were majority independent.  The 10 member board was half conflicted, half not – but the committees that negotiated the specific transactions were majority independent, because plaintiffs were only able to show 2 of the 4 board members with financial ties to Malone were dependent.  If they had gotten all 4, the committees would have been majority conflicted.  But because plaintiffs only made the case for 2, each committee was majority unconflicted. Two of the 7 member committee that addressed the call right were conflicted.  One of the 3 member committee that negotiated Maffei’s compensation was conflicted.

Therefore, as I understand it, although the court did not say so explicitly, these transactions would be cleansed and subject to business judgment review unless Maffei and Malone were controllers.  If they were controllers, business judgment review would only be available if there was also a stockholder vote and MFW procedures.  Which did not happen. 

As far as I can tell, then, the finding of control was critical.  The plaintiff was able to show the full board was conflicted for the purposes of demand excusal because of various personal ties particular board members had to Malone and Maffei, but there would still have been the question whether the underlying transactions gave rise to a claim.  And the only reason they did was because – despite the fact that majority independent committees of the dependent board negotiated the deals – independent committees are not enough to cleanse under MFW.

And that’s why the shareholders were able to survive a motion to dismiss, and proceed to discovery.

Oddly, Glasscock’s opinion did not mention this.  He found Malone and Maffei were controllers at least for these transactions, but did not explain why this was legally relevant.

Now, there is another interpretation of the opinion.  The finding of control was not that Malone and Maffei were general controllers; together, they held less than 50% of the vote (47.5%, in fact).  So, rather than simply call them a general control group, Glasscock found they were specific controllers, with respect to this particular deal.  Here is what he said:

Because Malone and Maffei together own less than 50% of the Company’s combined voting power, the operative question is whether they “exercise control over the business affairs of [Qurate].” ... Because I find it reasonable to infer that Malone and Maffei controlled the specific transactions at issue, I need not reach the question of general control, at least at this pleadings stage.

As an initial matter, I find that Plaintiffs have successfully pled that Malone and Maffei were potential controllers. The voting block that these two men controlled was significant and likely would have been dispositive in a contested board election.106 Indeed, the very existence of the Call Agreement supports an inference that the Company itself recognized the potency of Malone’s voting power, such that it spent $150 million in 1998 on the conditional option to buy those votes back. Evaluating the facts pled from the appropriate plaintiff-friendly perspective, I find at the pleading stage that Malone’s voting power, combined with his close association with the Company and Maffei’s role as its chairman, suggests that Malone’s “insistence on a particular policy or result had the potential to sway the business judgment of the directors and the executives of [the Company].”

Having found that Malone and Maffei had the potential to control the Company, I further find that Plaintiffs have pled sufficient facts to support an inference that Malone and Maffei exercised that control. Here, the impetus for the exercise of the Call Right came directly from Malone and Maffei.  The two men then failed to wall themselves off from the decision-making process. Plaintiffs allege that Malone and Maffei attended the initial meeting where the Board discussed the Offer, at which Malone expressed his desire to accept and his “preference to settle the Call Right in shares of the [Company’s common stock.]”  Subsequent negotiations to resolve the downstream impacts of exercising the Call Right on Maffei’s employment and compensation provided additional opportunities for the controllers’ preferences to “numb the minds or overcome the business judgment of the other directors.”

In sum, Malone and Maffei were potential controllers who stood on both sides of a challenged series of transactions...

That might be interpreted to mean that Malone and Maffei kind of overwhelmed the board committees, so that the board committees did not in fact operate with independence, which would mean MFW or not, there still would be no cleansing.  I.e., if they overwhelmed the board committees, then no independent structure checked them at all, and this was simple self-dealing.  But if that is the appropriate interpretation of the opinion, it is an odd way to get there.  Glasscock would not have had to designate Malone and Maffei as controlling shareholders in the legal sense – Glasscock could simply have held that they overwhelmed the committees.  Also, Glasscock did not go on to identify any facts suggesting that Malone and Maffei overwhelmed the committees, other than their mere presence in that initial board meeting. That sounds like the kind of control that clouds the judgment of even ostensibly independent directors, requiring the additional check of a shareholder vote.

Because according to Glasscock, Malone and Maffei may have violated their fiduciary duties as controllers on both sides of a transaction, but the directors who negotiated with them did not violate their fiduciary duties.  Instead, Glasscock found that the independent committees, despite the presence of a minority of financially conflicted directors, adopted the deals after reviewing them and finding them to be in the company’s best interests.  See, e.g., op. at 32-33 (“A simpler explanation of the same facts pled, consistent with Delaware courts’ presumption of independent directors’ fidelity to their fiduciary duties, is that the Compensation Committee adopted the deal after reviewing its structure and finding it to be in the Company’s best interests, given the options that would remain after the Company elected to exercise the Call Right.”). 

I mean, you could interpret the opinion to mean that if only Malone and Maffei had not attended that initial meeting, before the committees were formed – if only they had courier-delivered a formal proposal to the remaining board members gold-scripted on vellum or something – the whole deal would have been just fine.  I find that ... implausible.  The more likely interpretation is that Malone and Maffei had enough presence in the company that their views just carried weight even with board members who tried to do the right thing, which, again, is why MFW procedures exist.  Glasscock did not identify any places where Malone and Maffei were deemed to have actually influenced/threatened/coerced the majority-independent board committees; Glasscock simply said Maffei and Malone’s presence, coupled with their voting control, was influence enough to taint the board.

So I think the correct interpretation here is that Malone and Maffei were deemed limited controllers (due to their involvement in this particular deal), which meant cleansing could only occur via MFW procedures regardless of the formal independence of the two committees, MFW procedures were not employed, therefore there was no cleansing, therefore the complaint was sustained.    

If that is correct, if the only reason that this deal was not cleansed was because MFW was not employed, then that just highlights how important it is that the Delaware Supreme Court has called for briefing on whether to limit MFW to squeeze out deals, so that other kinds of interested controller transactions may be cleansed by independent boards alone.  If the Delaware Supreme Court so holds, it would mean that this transaction would have been cleansed.  This transaction, involving two repeat abusive controllers, who stocked the board with allies who had multimillion dollar relationships with them, who made an obvious play to trigger reciprocal financial benefits for each other, would be cleansed and immune from shareholder challenge under the standards currently being proposed.

At the very least, if MFW is so limited, it would mean that this transaction by a shareholder group with 47.5% of the vote would have been deemed cleansed if only Malone had gone for the courier-delivered vellum proposal before entering the board room.

Or, more likely – and this is what I’ve said before in my Three Faces of Control paper (at 821) – Delaware Chancery courts would be much more motivated to find a lack of independence.  Remember those 2 directors who had “generational wealth” conferred by Malone, yet still were found to be independent?  There would have been far more pressure to conclude they were, in fact, dependent.  If Glasscock had so found – if he had found that all four board members with financial ties to Malone were conflicted, rather than just two of them – it would have meant both committees were majority-conflicted, and the deal would not have been cleansed even the ordinary way. 

In the absence of MFW, equity’s gonna either have to find an alternative outlet, or go begging.

Ann Lipton | Permalink


Fantastic insight as always. Thanks.

Posted by: VSJB | Jul 24, 2023 6:02:19 AM

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