Thursday, February 22, 2024

Delaware's TripAdvisor Decision

Vice Chancellor Laster has issued his opinion in the TripAdvisor case.  I'm still digesting it, but the overall framework does not surprise me.  As I can't improve on the opinion's recitation of the basic factual situation, here it is:

A Delaware corporation has two classes of stock. The CEO/Chair owns highvote shares carrying a majority of the outstanding voting power, giving him hard majority control. The board decides to convert the Delaware corporation into a Nevada corporation, and the CEO/Chair delivers the necessary stockholder vote. The board does not establish any protections to simulate arm’s length bargaining. The conversion is not conditioned on either special committee approval or a majority-ofthe-minority vote.

A stockholder plaintiff challenges the conversion.1 The plaintiff argues that Nevada law offers fewer litigation rights to stockholders and provides greater litigation protections to fiduciaries like the directors and the CEO/Chair. The plaintiff alleges that the directors and the CEO/Chair approved the conversion to secure the litigation protections for themselves. In support of those assertions, the plaintiff cites the materials the board considered, disclosures in the company’s proxy statement, the work of distinguished legal scholars about the content of Nevada law, and public statements by Nevada policy makers about the direction Nevada law has taken.

I appreciate that the opinion gives a neutral framework under Delaware law for how to assess liability for changes in governance and litigation rights.  Although it's Nevada today, Tesla might be jumping to Texas tomorrow.  This decision provides guidance for how to think about that problem.  This passage does a good job presenting the issue:

Holding that the plaintiffs have stated a claim on which relief can be granted does not discriminate against Nevada entities. The same reasoning would apply if a Delaware corporation converted into another Delaware entity in a transaction with comparable implications. Using the contractual freedom conferred by the Delaware Limited Liability Company Act, entity planners can implement a wide array of governance schemes that provide fewer rights to investors than what stockholders in a Delaware corporation enjoy. If a Delaware corporation converted into a Delaware LLC where the governing agreement had eliminated all fiduciary duties, then the same reasoning would hold. Entity planners could even design a Delaware LLC that mirrors the internal governance structure of a Nevada corporation. If a Delaware corporation converted into that LLC, the outcome would be the same.

After deciding that the entire fairness standard will apply, the decision also clearly charts a path to leave Delaware without any liability:

Nor does this decision mean that a corporation can never leave Delaware without litigation risk. If a board proposed a similar conversion for a corporation without a stockholder controller, and if the fiduciaries fully disclosed the consequences of the change in legal regimes, including the effect on stockholder litigation rights, then the stockholders’ approval of the conversion would be dispositive, triggering an irrebuttable version of the business judgment rule. If directors proposed a similar conversion for a corporation with a stockholder controller, and if they properly conditioned the transaction on the twin MFW protections, then the dual approvals would be dispositive, again triggering an irrebuttable version of the business judgment rule.

For some public companies, Nevada may be a better fit than Delaware simply because of the cost issue.  Controlled corporations can exit with a two-step process and corporations without a controlling stockholder can make the move with a simple shareholder vote.

Going forward, a real challenge will be deciding how to value the change in litigation rights.  The opinion sketches out a possible market method:

The standard legal remedy is money damages. It seems quite likely that the court can craft a monetary remedy in this case that would be adequate. The remedial challenge will be to quantify the extent of the harm, if any, that moving from Delaware to Nevada imposes on the unaffiliated stockholders.

One way to determine the quantum of harm would be to value the Company pre-conversion as a Delaware corporation, then value the Company post-conversion as Nevada corporation, subtract the Nevada value from the Delaware value, and calculate a per share amount. That would be hard.

But there is another way to get at the delta. The Company’s stock has a trading price. In the conversion, nothing will change except the Company’s corporate domicile. Maffei’s control will remain constant. The Company’s business will remain constant. The only independent variable is the law governing its internal affairs.

Given that set-up, the change in the Company’s trading price should help quantify the harm, if any, caused by the conversion. As long as the market for the Company’s common stock is semi-strong-form efficient, then the price reaction should be indicative. Note that the stock price need not fairly approximate a pro rata share of the Company’s intrinsic value for the price reaction to matter. As long as any pricing disconnects remains consistent across variables other than the governing law, the price impact should provide insight.

From a Nevada perspective, the state will hope that companies trade up after these moves.  I previously proposed using markets to evaluate governance changes.  Although this method might shed some light on the valuation question, it's going to be a challenge.  Of course, this may also open the door to some disclosure gamesmanship.  It seems possible that a corporation announcing or completing this kind of move to Nevada might also selectively reveal some positive information at the same time.  That would increase the likelihood the stock would trade up and perhaps cloud or mask any impact from investors selling on the loss of their governance rights. 

It's probably worth also taking a look at other corporations that have made this move and what happens with their stock price.  If Delaware law and Nevada law are somewhat constant, you could likely get a better sense of the effect these moves have on valuation by getting a bigger dataset together.

If we're looking at changes in litigation rights and using this framework here when a company shifts from Delaware to Nevada or from a Delaware Corp. to a Delaware LLC, would we also use it for other governance changes?  What about a move to amend the bylaws in some way that affects litigation rights or a move to add a 102(b)(7) provision to a corporate charter?  My first thought is that the same framework should apply.  

In any event, this is going to be fun to watch.

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