Originally published in ALM's Delaware Business Court Insider
Whether a party is a controlling stockholder in a conflicted transaction determines the standard of review. If a stockholder owns more than 50% of the voting shares and therefore can control the board, there is no question it is a controlling stockholder. If the stockholder owns a large block but less than a majority, then whether it is a controlling stockholder is context dependent. Even if a party is not deemed a controller, if the transaction is an end-stage cashout merger, then the transaction may be subject to enhanced scrutiny unless fully informed and uncoerced, disinterested stockholders approve the transaction. In Anchorage Police & Fire Retirement System v. Adolf, C. A. No. 2024-0354-KSJM (April 3, 2025), the Delaware Court of Chancery rejected a claim that a 20.6% stockholder was a controlling stockholder but held that plaintiff adequately had alleged one of its several claims of deficient disclosure and so permitted limited discovery solely into that one claim.
Background
Anchorage involved a stockholder challenge to a merger transaction resulting from an eight-month sale process. The seller formed a special committee to run the sale process four months after the sale process began, advised by a Delaware law firm and two financial advisers. One stockholder owned 20.6% of the seller’s equity. The seller also was party to a credit agreement that provided for acceleration of the seller’s approximately $2.5 billion debt upon a “change of control,” defined to include a party acquiring 35% or more of the seller’s voting stock. The credit agreement included a carveout if certain permitted holders, including the owner of the 20.6% equity bloc, had the right to elect or otherwise designate for election in the new company at least a majority of the seller’s board. The 20.6% holder also had a right to a lump-sum payment of certain tax receivable agreement benefits upon a change in control. The special committee members also had a right to certain tax receivable agreement benefits in certain circumstances. A private equity buyer was the first to express interest with a written offer at $50 per share that also mentioned the bidder’s reputation for helping management and that it “would be an outstanding partner for the management team.” The seller’s financial adviser counseled that it was unlikely that a strategic buyer would emerge as a potential acquiror. Nonetheless, three months into the process, management met with a strategic buyer at the suggestion of the financial adviser, a meeting not reported to the board. Even though it later learned that the strategic buyer was prepared to pay $2 more per share, the special committee accepted a deal at $53 per share favored by the holder of the 20.6% bloc in which that holder would roll over 10% of its equity interest and receive the right to appoint a majority of the post-merger board. The strategic buyer’s bid, in contrast, did not require a management rollover of its equity. One day prior, the board had increased the compensation of the special committee chair from $80,000 to $280,000 and the other three special committee members from $40,000 to $240,000. The Merger Agreement also provided for the accelerated vesting of the special committee members’ tax receivable agreement benefits. The plaintiff brought a class action challenging the fairness of the transaction, claiming that the transaction merited entire fairness review because it involved a conflicted controller, and even if not, that inadequate disclosures prevented Corwin cleansing.
Court Rejects Plaintiff’s Claim That the Transaction Involved a Controlling Stockholder
The court conducted a careful holistic analysis and concluded that the plaintiff had failed to allege sufficient facts to indicate that the holder of the 20.6% bloc exercised general or transaction-specific control over the transaction. While the court agreed that the stock ownership, voting power to elect two of the nine-person board, and rights under the credit agreement were factors indicating that the 20.6% holder could exercise influence, these factors did not suffice to demonstrate transaction-specific control. The court viewed the potential taxable receivable agreement payouts as suggesting a potential conflict but not evidence of control. Similarly, the court found that the plaintiff failed to allege sufficient facts to suggest that the last-minute increase in special committee compensation created a “degree of owingness” to the large equity holder. The court also rejected the plaintiff’s claim that historical ties or parallel interests of the large equity holder with certain officer directors evidenced a control group. Accordingly, the court held that the transaction did not involve a controlling stockholder or group and therefore was not subject to entire fairness review.
Court Finds One Claim of Deficient Disclosure Prevents 'Corwin' Cleansing
The court rejected all but one of the plaintiff’s eight claims of deficient disclosure, finding inadequate the seller’s description of the interaction with the strategic bidder. What the court found potentially material were plaintiff's allegations that the seller misrepresented that the special committee’s agreement to exclusivity with the private equity buyer in the month prior to the final transaction was based on the strategic buyer’s being behind in its due diligence. The court relied upon the plaintiff’s allegation that the “Defendants iced the strategic buyer out of the sale process” to conclude that, if true, a reasonable stockholder would find this fact material. The court buttressed its materiality conclusion by noting that one of the special committee’s financial advisers had advised throughout the sales process that the strategic buyers would not be interested in the seller. The defendants sought to introduce facts outside the complaint from documents produced in response to a Section 220 books and records demand not to demonstrate that plaintiff’s factual allegations were inaccurate, but to contradict well-pleaded allegations in the complaint. This caused the court to convert their motion to dismiss to a motion for summary judgment, to deny the motion, and to permit discovery limited to the seller’s interaction with the strategic buyer.
Key Takeaways
A plaintiff seeking to invoke entire fairness review based on an alleged conflict of interest transaction with a controlling stockholder must allege sufficient facts to demonstrate general or transaction-specific control. Where a stockholder owns a substantial percentage of equity such as 20.6% but does not have contract or other rights to elect a majority of the board, then a plaintiff must allege sufficient other facts to demonstrate the stockholder exercised actual control. The court carefully addressed each of the plaintiff’s control allegations but found them wanting in this case based on a holistic analysis. Similarly, if a defendant seeks to rebut alleged disclosure deficiencies by introducing facts outside the record for a motion to dismiss, then the court may convert a motion to dismiss to a motion for summary judgment. This case demonstrates that in the latter circumstance, the court may deny the motion but limit discovery to the allegations that created the factual issue.
A plaintiff seeking to invoke entire fairness review based on an alleged conflict of interest transaction with a controlling stockholder must allege sufficient facts to demonstrate general or transaction-specific control. Where a stockholder owns a substantial percentage of equity such as 20.6% but does not have contract or other rights to elect a majority of the board, then a plaintiff must allege sufficient other facts to demonstrate the stockholder exercised actual control.
