United States: Delaware Chancery Court Appraisal Price Almost 30% over Merger Price; New York Adopts Delaware Standard for Review of Controlling Stockholder Mergers (Corporate Alert: June 2016)

The Herrick Advantage

Herrick is pleased to have represented Silas Capital in its investment in Boll & Branch ("B&B"), a luxury bedding and linens brand that ethically sources its products. In keeping with its "fairness from the ground up" philosophy, B&B uses a cost-saving, online direct-to-consumer model and passes the savings to its farmers, factory workers and customers. Silas Capital will play an active role in helping B&B increase sales and market share, and further solidify the company's position in the emerging direct-to-consumer luxury home textiles category. Corporate partner Irwin Kishner and counsel Joel Wagman represented Silas on the deal.

Delaware Chancery Court Appraisal Price Almost 30% over Merger Price

The Delaware Chancery Court ruled that merger consideration offered in a going-private transaction did not reflect the "fair value" of the company's common stock. As a result, the company was required to pay the dissenting stockholders that perfected appraisal rights a 28% premium over the merger consideration paid to stockholders that approved the going-private transaction. The Court reached its ruling despite evidence that a lengthy and robust sales process had been engaged in by the company. The Court found that the company's investors were focused on the short term and as a result there was a significant valuation gap between the market price of the company's common stock and the intrinsic value of the company. Additional factors which led to the Court's ruling were (i) the status of the going-private transaction as a management-led buyout rather than an arm's-length, third-party merger; (ii) the decision of the special committee of directors not to contact any potential strategic bidders; and (iii) the relatively large size of the going-private transaction. This decision serves as a reminder that appraisal exposure continues to be an important consideration for buyers of public companies incorporated in Delaware.

In re Appraisal of Dell Inc., C.A. No. 9322-VCL (Del. Ch. Ct. May 31, 2016)

New York Adopts Delaware Standard for Review of Controlling Stockholder Mergers

The New York Court of Appeals adopted the business judgment standard of review established by the Delaware Supreme Court for going-private mergers involving a controlling stockholder. The controlling stockholder made an offer to take the company private which was conditioned upon the approval of both a special committee of independent directors and the vote of a majority of the minority stockholders. After months of negotiation, the going-private transaction was approved by the special committee and 99% of the minority stockholders. Despite such approvals, certain stockholders filed suit claiming that the going-private transaction should have been subject to scrutiny under the heightened "entire fairness" standard of review. Application of the "entire fairness" standard of review would place the burden on the directors to show that they engaged in a fair process and obtained a fair price. In contrast, under the business judgment standard of review, the Court will afford deference to decisions made by directors in the absence of fraud or bad faith.

The Court unanimously disagreed with the position of the stockholders that filed suit. In reaching its decision, the Court reasoned that overall the business judgment standard of review properly considers the rights of the minority stockholders and weighs them against the interests of the directors and controlling stockholders in avoiding frivolous litigation and protecting independently made business decisions from unwarranted judicial interference.

In re Kenneth Cole Prods., Inc. S'holder Litig., No. 54 (N.Y. Ct. of App. May 5, 2016)

SEC Settles Unregistered Broker-Dealer Enforcement Action Brought Against Private Equity Fund Advisor

The SEC settled an enforcement action brought against a private equity firm advisor and its owner. The SEC alleged that the advisor acted as an unregistered broker-dealer with respect to certain activities involving the advisor's portfolio companies. The Securities Exchange Act of 1934, as amended, defines a broker as any person engaged in the business of effecting transactions in securities for the account of others. The specific actions engaged in by the advisor were the solicitation of deals, identification of buyers or sellers, negotiation and structuring of transactions, arrangement of financing and execution of transactions on behalf of the advisor's portfolio companies. The settlement required the payment of more than $3 million in total fines, including disgorgement and interest penalties. This enforcement action marks the first time the SEC has taken the position that the receipt of portfolio company transaction fees by a private equity firm advisor triggers an obligation to register as a broker-dealer.

Blackstreet Capital Mgmt., LLC, Exchange Act Rel. No. 77959, Advisers Act Rel. No. 4411 (June 1, 2016)

New York Appellate Court Recognizes Minority Discount for Partnership Interest Valuation

The Appellate Division of New York's Second Judicial Department ruled in a case of first impression that a "minority discount" may be applied in determining the value of a partnership interest for purposes of Section 69 of the New York Partnership Law. Section 69 entitles a partner who has wrongfully caused the dissolution of a partnership to be paid the value of his interest in the partnership less any damages caused to his partners by the dissolution. The lower court found that the partnership had been wrongfully dissolved and in determining the value of the interest of the partner which caused the wrongful dissolution, applied a 15% discount for goodwill and a 35% discount to account for limited marketability. The lower court, however, refused to apply a minority discount concluding that it was not permitted to do so based upon case law involving valuation of a minority stockholder's stock in a close corporation. The case law relied upon by the lower court held that imposing a minority discount would conflict with equitable principles of corporate governance designed to prevent stockholders from being treated differently and may encourage oppressive majority stockholder conduct to drive out minority stockholders. The Appellate Division found that the concerns expressed in the corporate context were not implicated. In the case before it, the Appellate Division was not confronted with a dissolution caused by any action on the part of the majority, but rather the wrongful conduct of a minority partner.

Congel v. Malfitano, No. 220/07 (N.Y. Sup. Ct. App. Div., 2nd Dept. May 18, 2016)

Delaware Bankruptcy Court Recognizes Commencement of Chapter 11 Case Not Authorized under Operating Agreement

The Delaware Bankruptcy Court refused to recognize a secured lender's motion to dismiss a Chapter 11 case that had been commenced without the unanimous consent of all the members. The secured lender, an energy fund, had provided secured note financing to the limited liability company. As a result of a covenant default under the secured notes, the limited liability company agreed to amend its operating agreement to (i) admit the energy fund as a member holding a single unit for a capital contribution of $1 and (ii) require the unanimous approval of the members in order to institute a voluntary bankruptcy action. The energy fund argued that the limited liability company's bankruptcy case filing should be dismissed for lack of requisite corporate authority. The Court, however, held that the provision requiring the energy fund's consent in order to institute a voluntary bankruptcy action was void as a matter of federal public policy which strongly disfavors contractual provisions precluding business entities from seeking the rights and protections available under the federal Bankruptcy Code. In so holding, the Court found that the energy fund's primary relationship with the limited liability company was that of a creditor, rather than an equity holder.

In re Intervention Energy Holdings, LLC, Case No. 16-11247 (KJC) (Del. Bankr. Ct. D. Del. June 3, 2016)

Delaware Supreme Court Upholds Dismissal of Aiding and Abetting Claim Against Financial Advisor in Merger Transaction

The Delaware Supreme Court upheld the dismissal of a stockholder lawsuit brought against a board of directors and its financial advisor. The lawsuit was based on a claim that a financial advisor had aided and abetted a board of directors in breaching the fiduciary duty owed in the sale of a company via a merger transaction. The merger was approved by a fully informed, uncoerced vote of the company's disinterested stockholders. This approval was sufficient to invoke the application of the business judgment rule as the standard against which the fairness of the merger would be reviewed. The Court ruled that, absent an allegation of corporate waste, the business judgment rule warranted dismissal of the breach of fiduciary duty claim. Accordingly, since there was no viable claim against the board of directors for breach of fiduciary duty, there could be no aiding and abetting claim against the financial advisor.

Singh v. Attencorough, No. 645, 2015 (Del. Sup. Ct. May 6, 2016 (en banc))

Delaware Chancery Court Finds Board of Directors Did Not Act in Bad Faith With Respect to Projections

The Delaware Chancery Court dismissed claims that the board of directors of a target company acted in bad faith and breached its duty of loyalty by directing its financial advisor to ignore certain projections having application to the sale of the target company. The claimants alleged that the financial advisor was directed by the board of directors to ignore two sets of favorable projections. After reviewing the projections at issue, the Court found that the projections were highly speculative and based on unlikely scenarios. In dismissing the claims, the Court ruled that in order to successfully plead a claim of bad faith (which the Court noted was rare), the claimants needed to prove that the decision to exclude the projections was "so far beyond the bounds of reasonable judgment that it seems inexplicable on any ground other than bad faith."

In re Chelsea Therapeutics International Ltd. Stockholder Litig., Consol. C.A. No. 9640-VCG (Del. Ch. Ct. May 20, 2016)

Delaware Chancery Court Finds Improper Delegation of Authority by Limited Liability Companies

The Delaware Chancery Court ruled that a Delaware limited liability company ("LLC") managed by a board of directors and a manager-managed Delaware LLC lacked authority to delegate the power to act as a special litigation committee to a retired federal court judge unaffiliated with the limited liability companies. Based upon its review of the operating agreements for the Delaware LLCs, the Court found that the right to control litigation was expressly reserved for the board of directors and the manager, respectively. In particular, the operating agreements provided for the delegation of authority only to committees comprised of one or more directors or managers.

The Delaware LLCs unsuccessfully relied upon Section 18-407 of the Delaware Limited Liability Company Act. Section 18-407 provides that unless otherwise provided in the operating agreement, a member or manager of an LLC has the power and authority to delegate to one or more other persons the rights and powers to manage and control the business and affairs of the LLC. The Court ruled that the language of Section 18-407 was insufficient to overcome the specific language in the operating agreements addressing the manner in which litigation-related matters would be controlled.

Obeid v. Hogan, C.A. No. 11900-VCL (Del. Ch. Ct. June 10, 2016)

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