C.A. No. 758-CC (Del. Ch. Oct. 2, 2009)
The Court of Chancery applied the entire fairness standard of review to a merger between a corporation with a controlling stockholder and a third-party acquiror where the controlling stockholder, who could veto any transaction, and the minority stockholders received different consideration because the Court determined that the procedural protections intended to protect the minority stockholders’ interests were insufficient.
The merger agreement between John Q. Hammons Hotels, Inc. (“JQH”) and the acquiror provided that all holders of the publicly traded Class A Common Stock would receive cash in exchange for their shares and that the sole holder of Class B Common Stock, John Q. Hammons (who controlled approximately 76% of the voting power of JQH), would receive a small equity interest in the surviving limited partnership, a preferred interest with a large liquidation preference, and various other rights and obligations not shared with the minority stockholders.
Plaintiffs, holders of Class A Common Stock, argued that (1) Hammons breached fiduciary duties as a controlling stockholder by negotiating benefits for himself that were not shared with the minority stockholders, (2) the JQH directors breached their fiduciary duties by conducting a deficient process when negotiating the merger and by voting to approve the merger, (3) the JQH directors failed to disclose material information in the company’s proxy statement, and (4) the acquiror aided and abetted the breaches of fiduciary duties.
The Court rejected plaintiffs’ contention that Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110 (Del. 1994), mandated that the merger be reviewed under the entire fairness standard regardless of any procedural protections used. The Court held that Lynch only applies when a controlling stockholder stands on both sides of the transaction. Since the acquiror, who had no prior relationship with Hammons or JQH, offered to purchase the shares held by the JQH stockholders and negotiated separately with Hammons and with the special committee formed to negotiate on behalf of the minority stockholders, Hammons did not stand on both sides of the merger.
Although Lynch did not apply, the Court found that, because Hammons and the minority stockholders were competing for portions of the consideration [the acquiror] was willing to pay, and because Hammons could veto any transaction, it was “paramount – indeed necessary to invoke business judgment review – that there be robust procedural protections in place” to protect the minority stockholders’ interests. The Court applied the entire fairness standard of review because the JQH special committee had the power to waive the majority of the minority vote and because such vote required approval of a majority of the shares being voted instead of a majority of the outstanding minority shares. The Court stated that it would have applied the business judgment standard of review if the merger had been recommended by a disinterested and independent special committee and approved by stockholders in a non-waivable vote of the majority of all the minority shares. Emphasizing the use of majority of the minority votes as a check on the special committee process, the Court stated that these procedural protections must be pre-conditions to the transaction; they could not be cured by the fact that they would have been satisfied had they been used.
The Court noted that, although the procedural protections were not sufficient to invoke business judgment protection, they could have been sufficient to shift the burden of demonstrating entire fairness to plaintiffs. Because some of plaintiffs’ disclosure claims survived the motion for summary judgment, the Court left open the question whether the special committee’s process and approval were sufficient to shift the burden to the plaintiffs to prove entire fairness.
Applying the entire fairness standard, the Court denied defendants’ motion for summary judgment on the issue of fair price because there were legal and factual disputes regarding the opinion of JQH’s financial advisor that the value of the consideration Hammons received was fair because it was less than the cash consideration the minority stockholders received in the merger. The Court also denied cross motions for summary judgment on the issue of fair dealing. The Court rejected plaintiffs’ contention that the special committee’s process was ineffective because Hammons could veto any transaction, but found material issues of fact existed regarding plaintiffs’ allegation that Hammons’s improper self-dealing transactions depressed the price of the minority shares prior to the merger.
The Court found that material issues of fact remained with respect to several of plaintiffs’ disclosure claims, which included allegations that JQH failed to disclose potential conflicts of interest of the special committee’s legal and financial advisors, and denied summary judgment for such claims. The Court also denied summary judgment of plaintiffs’ claim that the acquiror aided and abetted the alleged breaches of fiduciary duties.
The full opinion is available here.