In In re PNB Holding Co. Shareholders Litigation, 2006 WL 2403999 (Del. Ch. Aug. 18, 2006), an action asserting both appraisal rights and fiduciary duty claims, the Delaware Court of Chancery held that (i) an interested transaction, otherwise subject to entire fairness review, would be entitled to business judgment rule protection if ratified by a stockholder vote of the “majorityof- the-minority outstanding,” (ii) the doctrine of acquiescence barred the claims of stockholders who voted in favor of the transaction, but did not bar claims by stockholders who merely accepted the transaction consideration, and (iii) a defense based on an exculpatory charter provision modeled after Section 102(b)(7) of the Delaware General Corporation Law is an affirmative defense that can be waived if not timely raised.
To effectuate its decision to reorganize itself as a sub-chapter S corporation, and to comply with S-corporation regulations, PNB Holding Company (“PNB”) reduced the number of its stockholders from over 300 to less than 75 through a cash-out merger (the “Merger”). It was anticipated that following the Merger, only 68 stockholders would remain in PNB. Of the stockholders who were cashed out, certain of them perfected their appraisal remedy, while others accepted the Merger consideration and then claimed that the Merger was unfair and that PNB’s directors breached their fiduciary duties (the “Plaintiff Class”).
The Delaware Court of Chancery determined that the Merger was subject to entire fairness review because PNB’s Board of Directors comprised ten directors, nine of whom, along with 27 of their relatives, remained as stockholders of PNB following the Merger. Although there was no single “controlling stockholder,” the Court found that a majority of the directors were financially interested in the Merger such that the entire fairness standard should apply. In the Court’s view, because PNB itself was providing the Merger consideration, to the extent the consideration was low, the interested directors could benefit personally following the Merger by sharing in any excess value retained by PNB. Where there is an interested transaction but no single “controlling stockholder,” the Delaware Court of Chancery held that such a transaction would be entitled to business judgment rule protection if approved by a vote of the “majority-of-the-minority outstanding,” as opposed to a “majority-of-the-minority voting.” Because a majority of the outstanding PNB shares cashed out in the Merger did not vote in favor of the Merger, the Court found that the Merger was not ratified by stockholder approval and remained subject to entire fairness review.
After determining the appropriate standard of review, the Delaware Court of Chancery turned to the issue of whether members of the Plaintiff Class who voted in favor of the Merger were now barred from challenging it. Here, the Court first observed that, in a controlling stockholder case (which this was not), the doctrine of acquiescence does not apply because stockholders do not vote and/or tender their shares voluntarily. Nonetheless, the Court held that stockholders can be deemed to have acquiesced in an interested transaction such as the Merger, noting that acquiescence requires a showing that the “plaintiff, by words or deed has acknowledged the legitimacy of the defendants’ conduct.” Having found that to be the case, the Court held that the claims of the stockholders who voted to approve the Merger were barred.
With regard to the members of the Plaintiff Class who did not vote in favor of the Merger but who later accepted the Merger consideration, the Delaware Court of Chancery held that acceptance of merger consideration is an abandonment of appraisal rights but not an acceptance, by words or deed, of the legitimacy of the directors’ conduct. Consequently, the Court ruled that these Plaintiff Class members were not barred from any recovery on the grounds of acquiescence. Some practitioners have suggested that this holding is contrary to the Delaware Supreme Court’s decision in Bershad v. Curtiss- Wright Corp., 535 A.2d 840 (Del. 1987), which held that the mere acceptance by stockholders of cash merger consideration constitutes acquiescence, barring recovery in an equitable action. Finally, the Delaware Court of Chancery noted that while an exculpatory charter provision adopted pursuant to Section 102(b)(7) is a statutorily authorized immunity, because it has been characterized by the Delaware Supreme Court as being “in the nature of an affirmative defense,” it can be waived if not timely raised and asserted.