The Delaware Court of Chancery, in Palkon v. Maffei, et al., C.A. No. 2023-0449-JTL (Del. Ch. Feb. 20, 2024), determined that a reduction in the liability exposure of a fiduciary due to the conversion of a Delaware corporation to a Nevada corporation, which conversion is approved by a controlling stockholder, will subject the conversion to the entire fairness standard of review absent the "twin MFW protections" required to obtain business judgment review (i.e., approval of an independent, adequately empowered special committee that fulfills its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders).[1]
In 2023, the boards of directors of each of TripAdvisor, Inc. (TripAdvisor) and Liberty TripAdvisor Holdings, Inc. (Holdings) authorized the respective conversions of TripAdvisor and Holdings from Delaware corporations into Nevada corporations (Conversions). In evaluating the merits of the Conversions, the boards of directors considered the benefits of Nevada law over Delaware law, which, pursuant to materials provided to such boards, include "greater protections against litigation for directors and officers, plus lower franchise taxes and fees." Neither board of directors formed a special committee to make a recommendation regarding its company's Conversion.
After the boards of directors authorized the Conversions, TripAdvisor and Holdings each submitted the applicable Conversion to a vote of its respective stockholders. The chief executive officer and chairman of Holdings (Maffei), who is also a member of the board of directors of TripAdvisor, controlled 43% of the voting power of Holdings, and Holdings controlled 56% of the voting power of TripAdvisor; for purposes of the motion to dismiss, defendants conceded that Maffei controlled both entities. To be approved, the Conversion of each of TripAdvisor and Holdings required the affirmative vote of a majority of the voting power of that entity. As noted by the court, assuming each of Holdings and Maffei cast all of their votes in favor of the Conversions, "only 5.4% of the unaffiliated [TripAdvisor] stockholders voted in favor [and] . . . only 30.4% of the unaffiliated Holdings stockholders voted in favor. Holdings and Maffei thus provided the decisive votes."
The plaintiffs, stockholders of both entities, challenged the Conversions and requested an injunction to prevent the Conversions from closing. The plaintiffs alleged that the Conversions were not entirely fair because each Conversion was a self-interested transaction. The defendants moved to dismiss for failure to state a claim upon which relief can be granted. At the onset, the court disposed of the defendants' argument that each Conversion satisfied the technical requirements of the Delaware General Corporation Law and was therefore legally permissible. The court noted well-settled precedent that in the review of any corporate action, a Delaware court must confirm whether the corporation complied with the statute and whether the directors acted in accordance with their fiduciary duties, and, therefore, the plaintiffs' allegation that defendants breached their fiduciary duties in approving the Conversions was a relevant consideration.
The court then considered which standard of review applied—the plaintiffs argued that the Conversions should be reviewed under the entire fairness standard (which may apply to transactions between a corporation and a controlling stockholder receiving a non-ratable benefit), and the defendants asserted that the business judgment rule should apply instead. Agreeing with the plaintiffs, the court noted that the defendants conceded for this motion that the Conversions involved controlling stockholders and that no one suggested that the "twin MFW protections" were utilized. The court further explained that "[t]he entire fairness standard has two dimensions: substantive fairness (fair price) and procedural fairness (fair dealing)."
The court explained that a non-ratable benefit may have been conferred upon the defendants following the Conversions because of the reduction in the defendants' liability exposure, and corresponding reduction in the stockholders' litigation rights, under Nevada law relative to Delaware law,[2] thus triggering an entire fairness review. The court explained, "a controller or other fiduciary obtains a non-ratable benefit when a transaction materially reduces or eliminates the fiduciary's risk of liability."
The defendants in Palkon argued there cannot be a "fair price" to evaluate in the Conversions because the minority stockholders of TripAdvisor and Holdings are receiving shares of stock of the newly converted entities rather than cash. The court disagreed and reiterated that the "'test of fairness' is whether the minority stockholder receives at least 'the substantial equivalent in value'" of the stockholder's interest held prior to the transaction. The court stated that, following the Conversions, "the unaffiliated stockholders will possess only the litigation rights provided by Nevada law [which] . . . litigation rights are inferably less than what Delaware provides." Stockholders' litigation rights run fundamentally to value because "the market will only value rights that the law would protect, and, thus, the price of an asset is inescapably dependent on the legal entitlements of the holder of that asset."
Because the defendants could not establish that the Conversions were entirely fair, the court denied the motion to dismiss and then considered whether enjoining the closing of the Conversions was a viable remedy. The court noted that preventing an entity from leaving the state is an "extreme result" with limited circumstances warranting it, none of which were present in Palkon. Permanent injunctions cannot be granted unless the plaintiff establishes that other remedies would be inadequate. The court determined that money damages would be adequate in Palkon, and therefore an injunction would not be appropriate. To calculate damages, the court speculated that the corporations, both pre- and post-Conversion, could be valued, and damages would equal the difference between the value of Delaware corporations and the value of the Nevada corporations. Alternatively, the court acknowledged that the shares of both TripAdvisor and Holdings are publicly traded, and therefore the court could look to the change in stock price before and after the Conversions to calculate damages.
Palkon makes clear that litigation rights of stockholders and litigation exposure of fiduciaries are fundamental components of the value of interests in a company. Transactions involving controlling stockholders that stand to impair these rights or reduce this exposure must be afforded the MFW protective mechanisms or risk being subject to the entire fairness standard of review, if challenged.
[1] Kahn v. M&F Worldwide Corp. (MFW), 88 A.3d 635 (Del. 2014).
[2] For the purpose of ruling on the motion to dismiss only, the court inferred that the stockholders' litigation rights would be impaired by the Conversions. However, the court noted that the defendants may later attempt to demonstrate that Nevada law and Delaware law are equivalent, and that Nevada law does not confer a material benefit upon the defendants in the form of a reduction in liability exposure.
