When a controlling stockholder is on both sides of a transaction, the Delaware courts' most searching standard of review, entire fairness, is likely to apply. That generally means that a plaintiff who can credibly allege unfairness is likely to survive a motion to dismiss. It does not follow, however, that plaintiff will prevail at trial. If defendants' trial evidence viewed holistically shows a fair process and a fair price, the Delaware Court of Chancery will enter judgment in defendants' favor. The court's decision in In Re BGC Partners, Inc. Derivative Litigation, Cons. C. A. No. 2018-0722-LWW (Del. Ch. Aug. 19, 2022) illustrates this dynamic.
The plaintiff in BGC Partners attacked a transaction whereby the buyer, controlled by the same person who controlled the seller, purchased the seller for $875 million and also invested $100 million in the seller's affiliate. The plaintiff claimed that the buyer overpaid to benefit the controlling stockholder at the expense and to the detriment of the stockholders of the seller. At trial the defendants were the controlling stockholder, the seller and one member of the special committee the seller had formed to negotiate the transaction.
Court Finds Process Flaws Not Fatal
The court acknowledged plaintiff established facts that supported unfair process. These included that the controlling stockholder initiated the transaction, that he "overstepped" in identifying advisors for the special committee and asking the co-chairs to serve, and had "one-off" discussions with one of the members of the special committee. The entire fairness test requires the court to look at all relevant factors and here, the court found that the cumulative evidence weighed in favor of procedural fairness: the special committee and its advisors were independent, the controlling stockholder was not part of the special committee's deliberations after it began to function, the special committee was fully informed with all of its diligence requests having been met, and the special committee bargained with the controlling stockholder to obtain "meaningful concessions" reflecting arms-length negotiations. Cumulatively, the court found that defendants had met their burden of proving procedural fairness.
Court Finds Defendants Proved the Financial Terms Were Fair
The court rejected the plaintiffs' claim that the most the buyer should have paid for the seller was $725 million, or $150 million less than what the buyer paid. The court found that a low $700 million initial figure mentioned by the controlling stockholder was not a "true offer." The court relied upon the price resulting from the parties' arms-length negotiations, the detailed opinion of the special committee's independent financial adviser, and the analyses of defendants' expert who found a range of fair values for the seller of between $805 million to $1,164 million. While the court noted the acquisition price was in the low end of that range, she concluded that the price was economically fair. This reflects that the entire fairness test requires the court not to pick a number but to determine whether the price at issue is within a range of fairness. The court rejected the plaintiff's analysis in part because his comparable transactions analysis was based on a stale transaction three years prior when the evidence reflected that financial circumstances had changed. It was problematic that the plaintiffs' expert did not adjust his analysis to reflect those changed facts. changed. As to the $100 million investment in the seller's subsidiary, the court noted that the special committee had reduced that investment by one-third and determined that the expert testimony established the fairness of that investment.
The BGC decision reflects the care with which the Delaware courts apply a unitary test in assessing whether at trial the defendants have met their burden to establish the fairness of a transaction where a controlling stockholder is on both sides. While the court acknowledged process flaws, her ultimate conclusion was that there was "no evidence that those problems rendered the process unfair." She similarly found that the individual defendant's behavior, while imperfect, did not reflect disloyalty. Instead, she found the evidence reflected that the director worked tirelessly with independent advisers to advocate for a deal structure that furthered the interests of the seller's minority stockholders. Ultimately, she found he was prepared to say no and walk away if the special committee could not obtain a deal it found fair. The BGC decision reflects that while a plaintiff may plead a case that will survive a motion to dismiss when the standard of review is entire fairness, that success does not mean a judgment at trial. It is only if the cumulative evidence at trial reflects disloyal acts, unfair process and unfair price that a Delaware court will enter judgment for the plaintiffs.
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