In a new decision, In re Crimson Exploration Inc. Stockholder Litigation,1 Vice Chancellor Donald Parsons of the Delaware Court of Chancery provides guidance on when, particularly in the deal context, a significant but less-than-majority stockholder may be considered a controlling stockholder and when a controlling stockholder may have a particular interest in a merger that triggers the rigorous entire fairness standard of review. The Crimson decision dovetails with another recent decision by Chancellor Andre Bouchard of the Court of Chancery, In re KKR Financial Holdings LLC Shareholder Litigation,2 which rejected a claim that a 1 percent stockholder of a company having significant involvement in the day-to-day management of the company was a controlling stockholder and that a merger between the company and the stockholder was subject to entire fairness review.
This new guidance is useful for a few reasons. The exacting entire fairness standard, unlike the deferential business judgment rule, requires defendant directors or controlling stockholders to show with respect to a transaction that the process and terms were fair. Certain recent Delaware decisions have underscored the stakes and implications associated with these issues—including Kahn v. M&F Worldwide Corp.,3 in which the Delaware Supreme Court held that squeeze-out mergers involving controlling stockholders, which ordinarily trigger entire fairness review, can be "returned" to business judgment review if—although, only if—certain conditions (such as the proper use of a special committee and majority-of-the-minority stockholder vote) are satisfied, and In re John Q. Hammons Hotels Inc. Shareholder Litigation4 and Southeastern Pennsylvania Transportation Authority v. Volgenau,5 in which the Delaware Court of Chancery held that mergers with third parties in which a controlling stockholder receives differential consideration could be subject to entire fairness review. These threshold issues—whether entire fairness might apply and whether it can be avoided—have meaningful implications both for transaction planning and the conduct of litigation.
The Decisions
Crimson involved a 2013 stock-for-stock merger in which Contango Oil & Gas acquired Crimson Exploration at a small 7.7 percent premium, with many members of Crimson management and Crimson directors assuming similar roles in the combined company and signing support agreements. The plaintiffs alleged that entire fairness review applied because Oaktree Capital Management and affiliates both (1) constituted a controlling stockholder and (2) obtained special benefits in the merger. On the first score, plaintiffs contended that Oaktree was a controller because of its 33.7 percent equity stake in Crimson, paired with various other factors, including: Crimson's CEO allegedly had a longstanding relationship with Oaktree; Oaktree allegedly "handpicked" Crimson's CFO, who, along with the CEO, had a significant role in negotiating the transaction; three Oaktree principals served on the seven-member Crimson board; and the remaining directors and executive officers were nominated or joined the company after Oaktree made its investment in the company in 2005 and allegedly were either "approved" or "handpicked" by Oaktree. As for the purported special benefits that Oaktree obtained, the plaintiffs pointed to two issues: Contango would pay off debt that Crimson owed to Oaktree with a 1 percent prepayment penalty, and Oaktree had secured a registration rights agreement (RRA), negotiated among Crimson, Contango, and Oaktree, that would permit Oaktree to sell its block of stock after the merger in a private placement. The plaintiffs asserted that these benefits prompted Oaktree to "cause[] the Company to be sold for a grossly inadequate price."6
Vice Chancellor Parsons began with the familiar premise that a controlling stockholder exists either where a stockholder owns a majority of a company's voting power or, short of that, a stockholder exercises control as a factual matter. Proceeding under the second test, the court included an extensive discussion and summary of earlier Delaware decisions parsing whether a less-than-majority stockholder was a controlling stockholder, emphasizing the factual nature of the analysis: ". . . the cases do not reveal any sort of linear, sliding-scale approach whereby a larger share percentage makes it substantially more likely that the court will find the stockholder was a controlling stockholder. Instead, the scatter-plot nature of the holdings highlights the importance and fact-intensive nature of the actual control factor."7 The court ultimately noted that control over a board's decision-making is the touchstone: "to adequately plead that a non-majority blockholder was a controlling stockholder, a plaintiff would have to allege facts to show that the blockholder actually controlled the board's decision about the transaction at issue."8 The court appeared quite skeptical that such facts existed in Crimson, remarking that Oaktree was just an "outside investment fund," rather than the type of domineering stockholder that appears in many of the precedent cases, Oaktree did not employ the members of management negotiating the merger, and less than a majority of the board was affiliated with Oaktree.9
The court went on to hold on alternative grounds that even if Oaktree were a controlling stockholder, the deal did not involve the type of controlling stockholder conflict that would trigger entire fairness review. Vice Chancellor Parsons summarized Delaware case law as effectively presenting three species of controlling stockholder transactions in which entire fairness review applies: (1) transactions where the controller stands on both sides (e.g., the controller is squeezing out the minority); (2) transactions where the controller "competes with the common stockholders for consideration" by seeking disparate consideration for its shares (e.g., an extra premium as payment for its control stake); and (3) transactions where the controller "extracts" some "unique benefit" (e.g., a release of claims, or a chance at needed liquidity, that would not be of value to the minority), even where the other stockholders nominally receive the same consideration.
The court reasoned that prepayment of Oaktree's debt did not qualify under any of these categories triggering entire fairness because it was not negotiated before the merger was signed and the Crimson board did not negotiate or approve the prepayment; rather, Contango apparently simply wanted to pay off the debt. As a factual matter, the court also noted that the prepayment benefit to Oaktree was small enough—around $1.75 million—that it could not reasonably be seen to have influenced Oaktree to propose a suboptimal merger price for stockholders relative to the portion of the merger consideration to which Oaktree would be entitled. The court further reasoned that even though Oaktree allegedly "demanded" the RRA as part of the transaction, the RRA was not a "sufficiently unique benefit" to trigger entire fairness, given that the public stockholders were not losing value as a result of the RRA being signed and that Oaktree would become a smaller stockholder in the larger combined public entity, which would itself provide much of the liquidity opportunities that the RRA would provide anyway.
Notably, in the course of this decision, Vice Chancellor Parsons addressed the "liquidity conflict" theory that plaintiffs frequently invoke where there is a large stockholder, especially when that stockholder is a private equity or venture capital fund—i.e., that, even though all stockholders are receiving the same (premium) consideration, the large stockholder used its alleged control to obtain liquidity because of some internal or personal need of the stockholder and therefore pursued a suboptimal sale. In Crimson, Vice Chancellor Parsons appears to have aligned himself with other members of the Court of Chancery who have been skeptical of such a conflict, quoting then-Chancellor Strine's decision in the 2012 Synthes case for the proposition that a large stockholder generally will be found to have a liquidity conflict only in a "very narrow set of circumstances" involving a "crisis" or "fire sale" in which the controller has an "exigent need" and agreed to a sale "without performing the basic sale tasks necessary to achieve a price reflecting the corporation's market value."10 Otherwise, "[s]tockholders generally are presumed to have an incentive to seek the highest price for their shares. That inference or presumption is even stronger in the case of large stockholders."11
The themes of the Crimson decision accord with those in Chancellor Bouchard's KKR decision issued only 10 days prior. In KKR, Chancellor Bouchard dismissed the claim that KKR was a controlling stockholder and that entire fairness therefore applied to the merger between KKR and the company in question. The plaintiffs' theory was that even though KKR owned less than 1 percent of the company's stock, KKR was nonetheless a controller because of the target company's level of dependence on KKR: KKR affiliates managed the administrative and day-to-day business of the company by way of a management agreement, which could not be terminated without the payment of a very large termination fee; all of the company's officers were employees of KKR and its affiliates; the company's business was entirely focused on financing KKR's leveraged buyout activities; and the business was generally completely reliant on KKR. Chancellor Bouchard, similar to Vice Chancellor Parsons in Crimson, rejected this theory and held that even though the range of options available to the target company was limited in light of all of these facts, eight of the company's twelve directors were independent from KKR and KKR did not otherwise exercise control over the board. The court distinguished the case from other potentially similar fact patterns in prior cases where a stockholder in question held significantly less than a numerical majority of a company's stock but nonetheless had significant veto power over the decisions of the board itself.
The Takeaways
At bottom, Crimson, along with KKR, addresses certain foundational and definitional questions: when a stockholder constitutes a controlling stockholder and when a deal involves benefits to the controlling stockholder that trigger entire fairness. With additional guidance on those questions, companies, large stockholders and their advisors should be better situated to determine when entire fairness might apply as the standard of review and when certain procedural protections might be employed in transactions to remove the entire fairness specter.
1 2014 WL 5449419 (Del. Ch. Oct. 24, 2014).
2 -- A.3d -- , 2014 WL 5151285 (Del. Ch. Oct. 14, 2014).
3 88 A.3d 635 (Del. 2014).
4 2009 WL 3165613 (Del. Ch. Oct. 2, 2009).
5 2013 WL 4009193 (Del Ch. Aug. 15, 2013), aff'd, 91 A.3d 562 (Del. 2014).
6 2014 WL 5449419, at *7.
7 Id. at *10 (emphasis added).
8 2014 WL 5449419, at *16.
9 Vice Chancellor Parsons also rejected an argument that Oaktree and another 14.9 percent stockholder constituted a control group because the other stockholder allegedly held debt and had parallel economic interests to Oaktree. Id. at *15.
10 Id. at *14, quoting In re Synthes, Inc. S'holder Litig., 50 A.3d 1022 (Del. Ch. 2012).
11 Id. at *17.
