Stay current on changes and developments in corporate law with a wide variety of resources and tools.
Sept. 10— A recapitalization is not “entirely fair” even when it is approved and implemented at a fair price if it results from grossly unfair dealings, the Delaware Court of Chancery ruled Sept. 4.
In a memorandum opinion, Vice Chancellor John W. Noble wrote “a price that, based on the only reliable valuation methodologies, was more than fair does not ameliorate a process that was beyond unfair. At least doctrinally, stockholders may be entitled to more than merely a fair price, but the difficulty arises in quantifying the value of that additional entitlement.”
In addressing that challenging question of what damages a stockholder plaintiff may receive in such a scenario, Vice Chancellor Noble determined that the court under its inherent equitable powers could shift the attorneys' fees and costs.
Because the matter was not addressed in post-trial briefing in this case, the court granted plaintiffs leave to petition the court for this purpose.
This case involves a 2002 recapitalization of a start-up streaming media company eventually known as Nine Systems Corporation. Before the recapitalization, three investors—Wren Holdings, LLC, Javva Partners, LLC and Catalyst Investors, LP—constituted “a control group” of stockholders. They combined to own approximately 54 percent of the company's stock and more than 90 percent of its senior debt.
Despite being well-positioned in a growing industry, the company continuously suffered “cash flow problems that threatened its continued existence.”
In 2001, the representatives of the company's control group decided that company needed a “restart” of its capital structure.
As a result, a recapitalization plan was sketched out, including a determination that the company was valued at $4 million. This valuation was the result of calculations that were performed by one stakeholder who was not a director, and the calculations were only documented by his “handwritten scribbles.”
Additionally, no other member of the board was able to testify as to how exactly the valuation was calculated.
Believing the company would fail without additional capital, Wren and Javva agreed to provide additional investments in the company in exchange for convertible preferred stock.
In August 2002, the recapitalization was implemented and afterward the control group held approximately 80 percent of the company's stock.
Four years later, the company sold itself to Akamai Technologies, Inc. for $175 million. As result of the Akamai merger, various minority shareholders filed the instant lawsuit against the control group and their representatives on the board.
The plaintiffs contended that the recapitalization was not entirely fair because it expropriated their economic and voting rights in the company. They alleged claims for breach of fiduciary duty, aiding and abetting, and unjust enrichment.
The court explained that under Delaware law, “entire fairness” of a transaction has two components: “fair dealing” and “fair price.”
Although acknowledging that their “process was not perfect,” defendants claimed the process they used was fair in light of the company's immediate need for cash.
Cognizant of Nine Systems's situation at the time of the restructure, the court still rejected this premise, opining that: “The general initiation of the Recapitalization was fair. … But, the specific sequence of events undertaken by the Defendants to implement the Recapitalization was not fair.”
Instead, looking at a variety of factors, Vice Chancellor Noble determined that there was unfair dealing in the recapitalization process.
In particular, evidence of the unfair process included: the fiduciary defendants' attempts to marginalize the one independent director; the fiduciaries' failure to recognize objections to the recapitalization; the lack of attempt on the part of the directors to become adequately informed on how the $4 million valuation was derived; and the failure to disclose material information to minority shareholders.
Despite this unfair process, the court still found the $4 million valuation of the company for purposes of the recapitalization was a fair price. In making this determination, the court factored that the company had no value in equity before the recapitalization.
“Regardless of how much the Plaintiffs may have been diluted in the Recapitalization, because their common stock had no value that could have been diluted, the Plaintiffs necessarily ‘received the substantial equivalent in value of what they had before.'”
However, the court refused to conclude that the recapitalization was an entirely fair transaction because of “the grossly inadequate process employed by the Defendants.”
According to Vice Chancellor Noble, “it must hold true that a grossly unfair process can render an otherwise fair price, even when a company's common stock has no value, not entirely fair.”
Here, the court nonetheless declined to award the plaintiffs monetary damages because it found any harm based upon the alleged lost opportunity to invest was too speculative.
However, the court noted generally that “[e]ven where a transaction was conducted at a fair price, a finding that the transaction was not entirely fair may justify shifting certain of the plaintiffs' attorneys' fees and costs to the defendants who breached their fiduciary duties.”
The court granted plaintiffs leave to petition the court for this purpose.
To contact the reporter on this story: Michael Greene in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Ryan Tuck at email@example.com
The opinion is available at http://www.bloomberglaw.com/public/document/In_re_Nine_Sys_Corp_Sholders_Litig_Consol_CA_No_3940VCN_2014_BL_2.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to firstname.lastname@example.org.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to email@example.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)