Minority owners can delay, disrupt, and possibly prohibit the sale of a company unless the majority owner takes certain precautions to show fairness of the deal and of the process.
As the economy improves, investment in energy companies is increasing. Larger companies or private equity groups will frequently buy into smaller companies whose owners have built their businesses over the course of many years and, accordingly, might have deep emotional ties to the business. Often times, original owners will seek to remain involved in the company as minority owners. The investor may feel comfortable with this arrangement, on the presumption that its position as majority owner will give it ultimate control over the direction of the acquired business.
Such arrangements are not without problems though, especially when the new majority owner later decides to sell the purchased company. The minority owners—faced with the prospect of losing involvement with the company they built up—can use their minority owner position to derail or delay such sales. Even if the board of directors (which is usually mainly comprised of individuals selected by the majority owner) has approved the sale, the minority owners can still argue that the price at which the majority owner is selling is too low and, therefore, both the majority owner and the board of directors are breaching their fiduciary duties to secure the highest value reasonably attainable for all owners.
While the business judgment rule generally protects the majority owner and board of directors from these types of claims, it is not without exceptions. The business judgment rule “is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Emerald Partners v. Berlin, 787 A.2d 85, 99 (Del. 2001) (citations omitted). The presumption protects a board-approved transaction unless the plaintiff can show that a majority of the directors were self-interested, lacked independence, were grossly negligent in failing to inform themselves, or that the transaction can be attributed to no rational business purpose. Brehm v. Eisner, 746 A.2d 244, 264 n.66 (Del. 2000). This presumption is no small obstacle for a plaintiff to overcome, but it is complicated when the majority owner controls the board of directors (e.g., it chooses a set number of board members). In such cases, the board may be treated as an interested party that may not be acting independently. See, e.g., McMullin v. Beran, 765 A.2d 910, 923 (Del. 2000). And, if the board is not independent, then the business judgment rule does not apply and the board and the majority owner must show the “entire fairness” of the transaction, which requires them to show that the sale satisfies the fair dealing and fair price tests. Emerald, 787 A.2d at 91. “The duty to deal fairly requires the fiduciary not to time or structure the transaction, or to manipulate the corporation’s value, so as to permit or facilitate the forced elimination of the minority stockholders at an unfair price.” Boyer v. Wilmington Materials, Inc., 754 A.2d 881, 899 (Del. Ch. 1999) (internal quotation omitted).
There are several actions the majority owner can take in the sales process to satisfy the entire fairness test.
Most importantly, the majority owner should engage a third-party to set-up a competitive bidding process. This will help to show that the company instituted a fair procedure to obtain a fair price. Sometimes, however, the sales process can provide a minority owner with support for its case. For example, the ultimate sales price is often lower than the price claimed in the marketing materials. A disgruntled minority owner can try to use such literature as an admission that the majority owner is selling the company for significantly less than its true value. A majority shareholder should therefore pay close attention to the marketing materials and the claims made therein, and diligently document the analysis that shows that the final sales price was a good deal for the company and the minority owners. Additionally, the company and majority owner should review all agreements with the minority owners to determine what type of notice of a sale is required. Many agreements do not require any notice. In those cases, the majority owner should carefully evaluate whether notice should be provided early or late in the process. On the one hand, the majority owner does not want minority owners disrupting the deal—so it may want to wait some time before informing those owners. On the other hand, the minority owners could argue that the lack of ample notice indicates that the majority owner strategically timed the transaction to disadvantage those minority owners. See McMullin, 765 A.2d at 919 (analyzing the timing of a proposed sale by the majority owner when evaluating whether the board satisfied its fiduciary duties to the minority owners).
In short, there are numerous pitfalls that could befall a majority owner selling a company with minority owners. Thus, when buying into a company, an investor should carefully consider whether to allow the seller to continue in the business as a minority owner. If the seller does stay on as an owner, and the majority owner later wants to sell the business, the majority owner should be mindful of whether its actions will support or detract from an argument that the sale was fair to the minority owners and was for a fair price.