Recent decisions in Tesla and Oracle offer new insight into how the Delaware Court of Chancery will evaluate whether, in a conflicted transaction, a minority stockholder is a controller and therefore subject to the elevated entire fairness standard of review, which requires demonstration of both a fair price and a fair process.
The Tesla(1) litigation arose from Tesla's merger with SolarCity, which was approved by a vote of the shareholders of both companies. Elon Musk owned a 22% equity interest in Tesla and served as its chair and CEO while also serving as a member of the SolarCity board of directors. In addition, Musk's cousin was the CEO of SolarCity. Musk also held a 22% stake in SolarCity. Although Tesla and Musk argued that Musk's beneficial ownership of only 22% of Tesla's stock should not cause Musk to be deemed a controller, the court found that Musk had "outsized influence" over the Tesla board, which made Musk a controller and subjected the transaction to the more rigorous standard of review. Several factors contributed to the court's finding, including that:
- the Tesla board did not form a special committee to evaluate the transaction;
- Musk had personally selected Tesla's financial and legal advisers for the transaction; and
- Musk was the public face of Tesla and was intimately and indistinguishably linked with the company.
The decision also appears to have been influenced by a requirement under Tesla's bylaws that a two-thirds supermajority of stockholders approve important corporate and governance decisions, such as board compensation and mergers and acquisitions. The court determined that the supermajority requirement made it extremely burdensome to approve any such transaction without Musk's support.
In Oracle(2) stockholders challenged Oracle's acquisition of NetSuite, which was allegedly controlled by Oracle's founder, Larry Ellison. In evaluating the independence of Oracle's directors for the purposes of determining whether the stockholder plaintiff was excused from having to demand that the board sue in connection with the NetSuite transaction, the court considered the stockholders' arguments regarding Ellison's alleged influence over the other directors. The court's analysis focused on the directors who comprised the special committee of the Oracle board formed to consider the potential NetSuite transaction. Although Ellison owns only 28% of Oracle's stock, and although the stockholders' arguments regarding Ellison's influence were somewhat unique, the court nevertheless concluded that he may have held enough influence over Oracle and the special committee members to render them not independent for purposes of the motion before the court.
Notably, while the Tesla and Oracle decisions have implications for the analysis to be conducted when determining whether minority stockholders can be deemed controllers of a company, they do not guarantee that the Delaware courts will view all allegedly domineering minority stockholders as having a controlling influence. In fact, in Dell, the Delaware Supreme Court found that, with respect to Michael Dell's management-led buyout, he was not a controller even though he controlled 16% of Dell and was a powerful figurehead at the company. The court's decision was guided by the fact that Mr Dell took several steps to ensure that the company ran a fair process in which he would not have outsized control, most notably by permitting an independent committee of the board to evaluate the transaction and consenting to a majority of disinterested stockholders' approval conditions. Mr Dell also agreed to cooperate with other potential buyers (and engaged with competing bidders in the diligence process), which further levelled the transaction playing field.
In certain circumstances, it may be unclear as to whether a Delaware court will find that a minority stockholder's influence is sufficient to render it a controller for the purposes of a challenged transaction. In such circumstances, the company and stockholder may consider pre-emptive actions to reduce the likelihood that the stockholder will be found to be a controller, including (alone or in combination):
- creating a fully empowered and independent board committee (and allowing the committee to hire its own financial and legal advisers);
- recusing the stockholder (and its board designee(s)) from the board deliberations;
- requiring the transaction to be approved by a majority of the unaffiliated stockholders;
- obtaining a fairness opinion;
- depending on the nature of the transaction, running a competitive auction process to encourage others to make offers; and
- if applicable, engaging with other interested parties and allowing them to perform due diligence.
For further information on this topic please contact Lisa Bebchick, Martin J Crisp or Marc Feldhamer at Ropes & Gray's New York office by telephone (+1 212 596 9000) or email (firstname.lastname@example.org, email@example.com or firstname.lastname@example.org). Alternatively, contact Benjamin J Dionne at Ropes & Gray LLP's Boston office by telephone (+1 617 951 7000) or email (email@example.com). The Ropes & Gray website can be accessed at www.ropesgray.com.
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