On October 24, the Delaware Court of Chancery dismissed a lawsuit filed by certain minority stockholders of Crimson Exploration, Inc. in In re: Crimson Exploration Inc. Stockholder Litigation, C.A. No. 8541-VCP (Del. Ch. Oct 24, 2014), which challenged a stock-for-stock merger (the “Merger”) of Crimson and Contango Oil & Gas Co. The plaintiffs alleged that a group of affiliated defendants, including Oaktree Capital Management, L.P., constituted controlling stockholders of Crimson that breached their fiduciary duties by selling Crimson below market value for self-serving reasons.
In dismissing the plaintiffs’ claims, Vice Chancellor Parsons concluded that (a) the plaintiffs failed to allege sufficient facts to support that (i) Oaktree, alone or with others, occupied a controller position owing fiduciary duties to stockholders and (ii) that a majority of Crimson’s board of directors (“Board”) was not disinterested and did not lack independence, and (b) therefore, the business judgment rule must be applied rather than the stricter entire fairness standard. In many respects, this decision echoes the opinion issued by the Court on October 24 in In re KKR Financial Holdings LLC Shareholder Litigation, C.A. No. 9210 (summarized here), in which the court dismissed a shareholder derivative suit also claiming a breach of fiduciary duties by an alleged controlling stockholder in a stock-for-stock merger.
Under the business judgment rule, there is a strong presumption in favor of actions taken by directors, and so long as the decision making process is reasonable, the court will defer to a board’s decisions. In contrast, the entire fairness standard—the highest standard of review in corporate law—shifts the burden to defendants to prove a transaction’s entire fairness, in respect of fair dealing and fair price. Vice Chancellor Parsons explained that, in order to apply the entire fairness standard to Oaktree and its alleged affiliates, the plaintiffs must have demonstrated that (1) not only is Oaktree a controlling stockholder but also (2) the Merger was a conflicted transaction due to the controller (a) standing on both sides of such transaction or (b) competing with the common stockholders for consideration by receiving disparate consideration, having a continuing stake in the surviving entity or receiving a unique benefit.
The court was skeptical of plaintiffs’ allegations that Oaktree was a controller given that (1) the alleged members of Oaktree’s control group were not connected in a legally significant way (e.g., by contract, common ownership, agreement or other arrangement, to work together toward a shared goal); and (2) Oaktree is an outside investment fund and the lead negotiators of the Merger were not employed by Oaktree. Furthermore, the court, even assuming that Oaktree did control Crimson, did not find the Merger to be conflicted—the other required element for the application of entire fairness—because (a) Oaktree had no pre-Merger relation to Contango, and thus did not stand on both sides of the transaction; and (b) any arguably disparate consideration to Oaktree by way of Contango’s prepayment fee of one percent on a second lien loan (the “Prepayment”), a significant portion of which was held by an Oaktree affiliate, or unique benefit received by Oaktree pursuant to a registration rights agreement, which Oaktree entered into with Contango (“RRA”), could not be considered Merger consideration given that the Prepayment and RRA were neither conditions to the Merger nor approved by the Crimson Board and were, in any event, insignificant.
The In re: Crimson opinion also describes another method by which a plaintiff could rebut the business judgment rule and instead have the entire fairness standard applied, namely, by showing the board was interested in the challenged transaction or lacked independence. Vice Chancellor Parsons found this method also to be inapplicable to the case at hand, given that Oaktree was not conflicted and did not appoint a majority of the Board, and a majority of the Board was independent and disinterested in approving the Merger.
The full opinion can be found here.