In Strougo v. Hollander, the Delaware Court of Chancery held that a fee-shifting bylaw did not apply to a former stockholder’s challenge to the fairness of a 10,000-to-1 reverse stock split that the corporation undertook in connection with a going-private transaction because (i) the bylaw was adopted after the stockholder’s interest in the corporation ceased to exist due to the reverse stock split and (ii) Delaware law does not authorize a bylaw that regulates the rights or powers of former stockholders. While the proposed 2015 amendments to the Delaware General Corporation Law, if adopted, would themselves invalidate fee-shifting provisions in corporate charters and bylaws, Delaware corporations should consider the implications of this opinion’s holding that former stockholders are not bound by bylaws (or, by implication, charter provisions) adopted after their interests as stockholders cease to exist.
Posts Tagged ‘Going private’
On November 20, 2014, the New York Appellate Division, First Department, in a case of first impression under New York law, ruled in favor of Kenneth Cole in a litigation where minority shareholders had challenged the fashion designer’s transaction to take private Kenneth Cole Productions, Inc. Mr. Cole controlled approximately 89% of KCP’s voting power and owned a 46% economic interest in KCP. Willkie Farr & Gallagher LLP represented Mr. Cole in the transaction and the class action litigation.
The Appellate Division found that the business judgment standard of review—and not the heightened entire fairness standard—applied to judicial review of breach of fiduciary claims because the transaction had been structured at the outset with dual protections of an independent special committee review and the vote of a “majority of the minority” (that is, non-Cole) shareholders. The judicial standard of review can have important litigation consequences, as cases governed by the business judgment rule can be dismissed at an early stage, as occurred here, whereas transactions governed by the “entire fairness” standard generally require discovery and further proceedings, which can be burdensome and expensive.
In Hamilton Partners, L.P. v. Highland Capital Management, L.P., C.A. No. 6547-VCN, 2014 WL 1813340 (Del. Ch. May 7, 2014), the Court of Chancery, by Vice Chancellor Noble, in connection with a challenge to a going-private transaction whereby American HomePatient, Inc. (“AHP”) was acquired by an affiliate of one of its stockholders, Highland Capital Management, L.P. (“Highland”), refused to dismiss breach of fiduciary duty claims against Highland. The Court held that, for purposes of defendants’ motion to dismiss, plaintiff alleged facts sufficient to support an inference that Highland, which owned 48% of AHP’s stock and 82% of AHP’s debt, was the controlling stockholder of AHP and that the merger was not entirely fair.
Are private firms more efficient than public firms? Jensen (1986) suggests that going-private could result in efficiency gains by aligning managers’ incentives with shareholders and providing better monitoring. In our paper, Do Going-Private Transactions Affect Plant Efficiency and Investment?, forthcoming in the Review of Financial Studies, we examine a broad dataset of going-private transactions, including those taken private by private equity, management and private operating firms between 1981 and 2005. We link data on going-private transactions to rich plant-level US Census microdata to examine how going-private affects plant-level productivity, investment, and exit (sale and closure). While we find within-plant increases in measures of productivity after going-private, there is little evidence of efficiency gains relative to a control sample composed of firms from within the same industry, and of similar age and size (employment) as the going-private firms. Further, our productivity results hold excluding all plants that underwent a change in ownership after going-private, alleviating the potential concern that control plants may undergo improvements through ownership changes.
The Delaware Supreme Court today affirmed that a going-private transaction may be reviewed under the deferential business judgment rule when it is conditioned on the approval of both a well-functioning special committee and a majority of the minority stockholders. Kahn v. M&F Worldwide Corp., No. 334, 2013 (Del. Mar. 14, 2014).
As described in our previous memo, the case arose out of a stockholder challenge to a merger in which MacAndrews & Forbes acquired the 57% of M&F Worldwide it did not already own. Then-Chancellor Strine granted summary judgment in favor of the defendants, finding that the record established the transaction was approved by both an independent special committee that functioned effectively and had the power to say no and the fully-informed vote of a majority of the unaffiliated stockholders, thus entitling them to business judgment review.
During 2013, in addition to the important changes to the Delaware General Corporation Law (“DGCL”) and the Limited Liability Company Act, described here, the Delaware courts issued a number of decisions that have a direct impact on the M&A practice. Below are our Top 5 case law picks for M&A practitioners:
1. A new look at the standard of review in going-private mergers (the Business Judgment Rule)
In its In re MFW Shareholders Litigation (May 29, 2013) decision, the Court of Chancery held that in going-private mergers with a controlling stockholder on both sides the deferential business judgment standard of review applies, instead of the entire fairness standard, if certain procedural safeguards are included from the beginning. Specifically, the controlling stockholder has to agree at the outset to proceed with the merger only if the transaction is both (1) negotiated and approved by an attentive special committee comprised of directors who are independent of the controlling stockholder and fully empowered to decline the transaction and to retain its own financial and legal advisors and (2) conditioned on the un-coerced, fully informed and non-waivable approval of a majority of the unaffiliated minority stockholders.
On September 3, 2013, a New York trial court dismissed a stockholder challenge to a going private transaction in which Kenneth Cole, who held approximately 47% of the Company’s outstanding common stock and controlled 90% of the voting power of Kenneth Cole Productions Inc. (“KCP”), purchased the remaining 53% of the common stock of KCP that he did not already own. Willkie Farr & Gallagher represented Mr. Cole in the underlying going private transaction and the class action litigation that ensued.
On February 24, 2012, KCP announced that Mr. Cole had proposed a transaction to take KCP private and to pay the public stockholders $15.00 per share, which reflected a 17% premium to KCP’s unaffected share price. KCP’s board created a special committee of four independent directors to negotiate with Mr. Cole, who conditioned his bid on the approval of the special committee and the affirmative vote of a majority of the minority stockholders. Mr. Cole made it publicly clear that he would not entertain any offers to sell his shares in a third party transaction and was only interested in buying shares from the minority stockholders. After several months of negotiations, Mr. Cole agreed to pay $15.25 per share. 99.8% of KCP’s shares unaffiliated with Mr. Cole that voted ultimately voted in favor of the transaction.
In Southeastern Pennsylvania Transportation Authority v. Ernst Volgenau, et al  (the “SRA” decision), Vice Chancellor Noble continued a recent trend in Delaware case law involving acquisitions of companies with a controlling stockholder—if robust procedural protections are properly used (such as the recommendation of an empowered, disinterested special committee and the transaction is conditioned on a non-waivable vote of the majority of all minority target stockholders), the standard of judicial review applicable to such a transaction will be the deferential business judgment rule. Accordingly, when a target company is acquired by a third party unaffiliated with the target’s controlling stockholder, the target company can avoid “judicial review under the entire fairness standard and, perhaps in most instances, the burdens of trial.”
Only a few weeks ago, in a precedent setting decision, Chancellor Strine held that the standard of judicial review applicable to going private mergers with controlling stockholders (i.e., transactions in which the buyer is affiliated with or is the controlling stockholder) should also be the deferential business judgment rule if certain similar robust procedural protections were properly employed. 
Historically, buyouts by controlling shareholders (also known as “going-private transactions,” “squeeze-outs,” and hereinafter “freezeouts”) were subject to different standards of judicial scrutiny under Delaware corporate law based on the transactional form used by the controlling shareholder to execute the deal. In a line of cases dating back at least to the Delaware Supreme Court’s 1994 decision in Kahn v. Lynch Communications, a freezeout executed as a statutory merger was subject to stringent “entire fairness” review, due to the self-dealing nature of the transaction. In contrast, in a line of cases beginning with the Delaware Chancery Court’s 2001 opinion in In re Siliconix Inc. Shareholder Litigation, a freezeout executed as a tender offer was subject to deferential business judgment review.
Subramanian (2007) presents evidence that, after Siliconix, minority shareholders received less in tender offer freezeouts than in merger freezeouts. Restrepo (2013) finds that these differences in outcomes occurred only after Siliconix, and that the incidence of tender offer freezeouts increased after this opinion, also supporting the idea that controlling shareholders took advantage of the opportunity provided by Siliconix. Subramanian (2005) describes why these differences in outcomes for minority shareholders create a social welfare loss and not just a one-time wealth transfer from minority shareholders to the controlling shareholder.
On June 13, 2013, the Securities and Exchange Commission (SEC) announced that it had reached a settlement with Revlon, Inc. (Revlon) regarding allegations that Revlon deceived minority shareholders in connection with a 2009 “going private” transaction.  Under Section 13(e) of the Securities Exchange Act of 1934 and Rule 13e-3 thereunder issuers are prohibited from taking fraudulent or deceitful actions in connection with a “going private” transaction. The SEC’s rules for “going private” transactions require disclosure, among other things, of any report, opinion, or appraisal from an outside party that is materially related to the transaction.  The SEC alleged that Revlon engaged in a variety of deceptive acts in order to avoid disclosure of a third-party financial advisor’s determination that the “going private” transaction would not provide adequate consideration for minority shareholders. Revlon did not admit or deny the SEC’s findings set forth in the cease-and-desist order, but agreed to cease and desist from committing any future violations and to pay an $850,000 penalty. Section 13(e) of the Securities Exchange Act of 1934 and Rule 13e-3 thereunder have rarely been the subject of SEC enforcement action. This settlement may signal that, just as the Staff of the Enforcement Division of the SEC is more generally expanding its enforcement reach into the area of private equity firms — which are often involved in going private transactions—its enforcement priorities may also be expanding into areas that have been historically addressed by private litigants in civil actions brought under state corporate fiduciary law.