Del. Court Allows Claims Against EZCorp Controlling Holder

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By Michael Greene

Jan. 26 — An EZCorp Inc. investor may proceed with a lawsuit challenging three advisory services agreements between the company and Madison Park LLC, an entity affiliated with EZCorp's controlling shareholder Phillip Ean Cohen.

In declining to dismiss the claims filed by Lawrence Treppel, the Delaware Chancery Court Jan. 25 applied the “entire fairness” standard of review instead of the business judgment rule, which is more deferential to corporate decision-making.

In a 91-page opinion, Vice Chancellor J. Travis Laster explained that the entire fairness framework isn't limited to claims challenging squeeze-out mergers—in which a majority stockholder forces out minority holders—but also applies to transactions in which a controlling stockholder receives non-ratable benefits.

“Of particular relevance to this case, Delaware decisions have applied the entire fairness framework to compensation arrangements, consulting agreements, services agreements, and similar transactions between a controller or its affiliate and the controlled entity,” Laster wrote.

Service Agreements Challenged

Treppel's lawsuit challenged the fairness of three agreements in which Madison Park would provide EZCorp with advisory services related to long-term strategic planning. The shareholder claimed that the agreements weren't legitimate contracts, but were means by which Cohen could extract non-ratable cash returns from EZCorp.

In his original complaint, Treppel named as defendants all the individuals who served on the company's board at the time the transactions were approved, Madison Park, Cohen and two entities through which Cohen controls EZCorp.

However, Treppel subsequently dropped his claims against all the individual defendants except Cohen and EZCorp board member Thomas Roberts .

Under EZCorp's capital structure, Cohen controls 100 percent of the company's voting power, despite owning only 5.5 percent of its outstanding stock.

The court observed that when controlling stockholders' rights diverge from their equity ownership, they have an incentive to engage in “tunnelling,” i.e., related-party transactions in which the corporation makes non-pro rata transfers of capital. In such transactions, the controlling shareholder receives all the benefits while only funding the deal to the extent of his or her equity stake.

Applying Entire Fairness

After concluding that the applicable standard of review was entire fairness, the court determined that the plaintiff's complaint reasonably showed that Cohen extracted a non-ratable return from the company. In reaching this inference, the court cited several factors, including:

  •  the capital structure of the company created a disincentive for Cohen to pay dividends and a strong incentive to obtain returns through direct transfers;
  •  the company's long history of entering into such agreements with entities affiliated with Cohen;
  •  the amount, timing and magnitude of the payments; and
  •  Cohen's retaliation against two outside directors who terminated the renewal of one of the service agreements.
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    The court also provided a detailed discussion over whether a pre-suit demand on the company's board to take action would be futile. In finding that demand was excused, the court determined that a reasonable doubt existed as to whether a majority of the company's directors had an interest in approving the transactions.

    To contact the reporter on this story: Michael Greene in Washington at mgreene@bna.com

    To contact the editor responsible for this story: Yin Wilczek at ywilczek@bna.com

    For More Information

    The opinion is available at http://src.bna.com/cev.