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By Michael Greene
Oct. 28 — Entire fairness review does not apply to transactions even when a company has a controlling shareholder if the controller does not engage in a conflicted transaction, according to an Oct. 24 Delaware Chancery Court ruling.
Vice Chancellor Donald F. Parsons Jr. opined that “a large blockholder will not be considered a controlling stockholder unless they actually control the board's decisions about the challenged transaction.”
The court also addressed when a stockholder owning less than 50 percent of the company could be considered a controlling stockholder and when a controller engages in a conflicted transaction despite not being on both sides of a challenged deal.
In this case, even though a 33 percent owner of company stock could have been deemed a controller, it did not engage in a conflicted transaction that would trigger entire fairness review.
The plaintiffs, Crimson Exploration Inc. stockholders, filed a class action challenging a stock-for-stock merger between the company and Contango Oil & Gas Co. The plaintiffs alleged that the transaction undervalued the company's stock price.
In their complaint, the plaintiffs contended that entire fairness was the proper standard of review of the transaction because the company's largest shareholder, Oaktree Capital Management, L.P., constituted a controller who caused the company to be sold for an inadequate value in exchange for significant side benefits and Crimson's senior management pursued extensions of employment and higher salaries, instead of seeking the highest exchange value.
At the outset, the court noted that the fact that Oaktree owned less than 50 percent of Crimson stock was not determinative in whether it was a controlling stockholder, remarking that “a stockholder ‘who exercises control over the business affairs of the corporation' also qualifies as a controller.”
The court provided a table of cases that applied the actual control test and opined that there was not a “linear, sliding scale approach” to determining what percentage of stock would make it more likely that a stockholder had actual control.
After an extensive review of several cases, Parsons opined that courts “have been reluctant to apply the label of controlling stockholder … to large, but minority, blockholders” absent significant facts to the contrary.
After dismissing allegations that a “control group” existed, the court noted that the complaint lacked specific allegations that Oaktree was a controlling stockholder of Crimson, merely relying on inferences that Oaktree and others colluded to advance their own interests at the expense of other company stockholders.
Even though Parsons determined that the plaintiffs' inferences were “questionable,” he still was “hesitant to concluded that Plaintiffs could not conceivably make” a showing that Oaktree controlled Crimson.
Nonetheless, the court refused to apply the entire fairness standard to this case.
Entire fairness is not triggered solely because a company has a controlling stockholder, Parsons wrote; “[t]he controller must also engage in a conflicted transaction.” He noted that a conflicted transaction could involve the controller standing on both sides of the transaction or when a controller receives a benefit that competes with common stockholders' consideration.
Here, the plaintiffs conceded that Oaktree did not stand on both sides of the disputed transaction.
Instead, they contended that Oaktree “competed” for consideration with Crimson's other shareholders by receiving two additional considerations from the merger.
The court, however, rejected the plaintiffs' contentions that these benefits constituted additional consideration.
“Stockholders are generally presumed to have an incentive to seek the highest price for their shares,” he wrote. Accordingly, the plaintiffs must present specific facts or theories to overcome this inference.
Parsons concluded that the plaintiffs failed to do so, and Oaktree received the same consideration as all other Crimson shareholders. Accordingly, the court declined to apply the entire fairness standard and reviewed the plaintiffs' claims under the business judgment rule.
The court found that the plaintiffs did not present any other facts sufficient to rebut the business judgment rule because a majority of Crimson's board was independent and disinterested in the transaction.
The plaintiffs argued that Crimson's senior management focused on improving post-employment packages instead of securing the best deal for the company's shareholders. However, the plaintiffs' complaint only alleged that three board members received such post-employment benefits and did not provide sufficient facts to support that these directors dominated the rest of the board.
Accordingly, because at least four board members were disinterested and independent, the business judgment rule applied.
Under that standard, the court dismissed the plaintiffs' claims.
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The opinion is available at http://www.bloomberglaw.com/public/document/In_re_Crimson_Exploration_Inc_Stockholder_Litig_No_Civil_Action_N.
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