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SMART SUMMARY
- A recent decision from the Court of Chancery in Delaware highlights the importance of sponsors hiring independent counsel when approaching a restructuring.
In Clement v. Apollo Glob. Mgmt., LLC, C.A. No. 2023-0904-JTL (Del. Ch. 2023), a group of minority shareholders of Redbox Entertainment Inc. alleged that private equity sponsor Apollo breached its fiduciary duties as controlling shareholder of Redbox.
The lawsuit arose from the merger of Redbox with Chicken Soup for the Soul Entertainment, Inc. (CSE). Around the time of the merger, Redbox's stock price experienced abnormal volatility and began to surge, earning its place among other “meme stocks”. Notwithstanding the merger price of $0.69 and that Redbox shares traded at around $1.28 per share prior to the merger being announced, Redbox's stock price ballooned up to $18.00 before the merger ultimately closed three months later.
After the merger, the minority shareholders alleged that Apollo received “unique benefits” not received by the minority shareholders. Such “unique benefits” allegedly included (i) the conversion of Apollo's outstanding $27 million loan into Redbox common shares and subsequent conversion of the Redbox shares into $2.8 million in CSE equity and (ii) a release of any potential claims against Apollo. The minority shareholders contended these alleged “unique benefits” subjected the merger to “entire fairness” review, which requires a higher level of scrutiny by the Court than the “business judgment” standard.
Apollo's Release of Claims
Prior to the merger, Redbox had formed a special committee of independent and disinterested directors and hired Weil to serve as independent counsel to assist in the exploration of strategic alternatives. As part of that strategic alternatives process, the independent directors conducted an independent investigation into any claims against Apollo. The investigation did not uncover any valuable claims against Apollo, and in connection with the merger, Redbox agreed to grant a release to Apollo. In its oral decision granting Apollo's motion to dismiss the lawsuit, the Court relied heavily on Weil's findings that there were no valuable litigation claims for the minority shareholders to assert.
Apollo's Debt to Equity Conversion
Apollo further argued that (i) the debt-to-equity conversion did not improperly divert merger consideration that would otherwise have been paid to the minority shareholders; (ii) under Delaware law, Apollo, as controlling shareholder, was free to exercise its contractual rights; and (iii) Redbox's independent special committee, not Apollo, decided to enact the debt-to-equity conversion.
“The Court's decision highlights the importance of forming a special committee of disinterested fiduciaries and hiring independent counsel to advise on related-party transactions …”
The Court ruled in Apollo's favor. The Court determined that the exchange was a “unique detriment [to Apollo] rather than a unique benefit” because, in bankruptcy, the common stock that Apollo converted into would have been “wiped out” since set behind both the Apollo loan and $440 million in debt secured.
Takeaways
The Court's decision highlights the importance of forming a special committee of disinterested fiduciaries and hiring independent counsel to advise on related-party transactions and conduct an independent investigation into strategic alternatives and potential legal claims when facing a potential bankruptcy filing.
Recent amendments to the Delaware General Corporation Law (DGCL) further underscore the benefits of hiring independent counsel when engaging in transactions in which a controlling stockholder receives a financial or other benefit not shared with the corporation's stockholders generally. Section 144(b) of the DGCL now provides for a “safe harbor” from liability for transactions involving a controlling stockholder in certain circumstances. Hiring independent counsel to assist the independent committee would evidence the committee's efforts to approve such transaction in good faith and without gross negligence, which is exactly what is required by the safe harbor in the new DGCL provision.
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