The Delaware Court of Chancery recently held that a stockholder of a Delaware corporation is a third-party beneficiary of a stockholder agreement that includes protections similar to those contained in Section 203 of the Delaware General Corporation Law, and therefore has standing to sue for breach of the agreement. Arkansas Teacher Retirement System v. Alon USA Energy, Inc., et al., C.A. No. 2017-0453-KSJM, 2019 WL 2714331 (Del. Ch. June 28, 2019).
Delek US Holdings, Inc. acquired 48% of the common stock of Alon USA Energy, Inc. from Alon’s largest stockholder in 2015. At the time, Delek expressed interest in acquiring the entirety of Alon’s outstanding shares. To avoid the three-year standstill period imposed under Section 203 of the Delaware General Corporation Law, Delek requested and obtained Section 203 pre-approval from Alon’s board, but conditioned its approval on Delek entering into a stockholder agreement. The stockholder agreement established anti-takeover protections similar to those imposed by Section 203, but for a period of only one year.
Delek and Alon ultimately negotiated the terms of a merger transaction, which was agreed to in January 2017, approved by Alon’s stockholders in June 2017 and consummated in July 2017.
The Plaintiff, an Alon stockholder at the time of the merger, brought various claims against Delek, Alon and their respective directors, including for breach of fiduciary duty, breach of the stockholder agreement and that the merger was prohibited under Section 203 and therefore void ab initio and thus constituted an act of conversion.
Under Delaware law, a third party to an agreement may sue to enforce the agreement’s terms if three elements are met:
- the contracting parties intended to confer a benefit directly to that third party;
- they conveyed the benefit as a gift or in satisfaction of a pre-existing obligation; and
- conveying the benefit was a material part of the purpose for entering into the agreement.
The Court determined that the stockholder agreement’s relationship to Section 203 rendered each of these elements satisfied. The stockholder agreement replicated many aspects of the anti-takeover protections of Section 203, which provide a direct benefit to stockholders of a Delaware corporation; therefore, the Court reasoned, the stockholder agreement provided a direct benefit to the Plaintiff. The agreement’s benefits were established in place of Section 203’s pre-existing protections, or were at least intended as a gift to the stockholders. The Court found that the purpose of the stockholder agreement was to restrict Delek’s ability to acquire Alon, thus without the anti-takeover provisions, the agreement would not achieve that purpose. The Court determined that the anti-takeover provisions were material and held that the Plaintiff has standing to enforce the stockholder agreement.
The Plaintiff also asserted that Delek and Alon violated Section 203 by entering into the merger, arguing that Delek’s violation of the stockholder agreement vitiated the approval of Alon’s board under Section 203, thereby restoring Section 203’s protections. The Plaintiff argued that since the protections were restored, Section 203 prohibited the merger, therefore the merger was void ab initio and thus when consummated constituted an act of conversion. Although the case is ongoing and the Court has yet to rule on Plaintiff’s line of reasoning, the Court rejected the Defendants’ argument that the alleged Section 203 deficiencies were necessarily cured through Section 203(a)(3) upon approval by Alon’s board and two-thirds of its disinterested stockholders on the basis that the Plaintiff adequately alleged that stockholder approval was not fully informed. In other words, the curative power of board and disinterested stockholder approval under Section 203(a)(3) must still meet the condition of fully-informed decision-making to cleanse a Section 203 violation.
The Plaintiff’s breach of fiduciary duty claims survived Defendants’ motion to dismiss and are headed toward either the business judgment or entire fairness standard of review, in-line with recent Delaware Supreme Court cases Kahn v. M & F Worldwide Corp. and Flood v. Synutra International, Inc.
While this case may or may not break new ground on the novel pending Section 203 claims, buyers, sellers and M&A practitioners should be aware that in certain circumstances, third-party stockholders of a Delaware corporation may have standing to sue for breach of a stockholder agreement between the corporation and a stockholder.