DENNIS PALKON AND HERBERT WILLIAMSON v. GREGORY B. MAFFEI, ALBERT E. ROSENTHALER, MATT GOLDBERG, JAY C. HOAG, BETSY MORGAN, GREG O‘HARA, JEREMY PHILIPS, TRYNKA SHINEMAN BLAKE, JANE JIE SUN, ROBERT S. WIESENTHAL, LARRY E. ROMRELL, J. DAVID WARGO, MICHAEL J. MALONE, CHRIS MUELLER, and CHRISTY HAUBEGGER, and TRIPADVISOR, INC. AND LIBERTY TRIPADVISOR HOLDINGS, INC.
C.A. No. 2023-0449-JTL
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
Date Decided: February 20, 2024
Date Submitted: November 8, 2023
Kevin R. Shannon, J. Matthew Belger, Jaclyn C. Levy, Justin T. Hymes, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Matthew W. Close, Jonathan B. Waxman, O‘MELVENY & MYERS LLP, Los Angeles, California; Abby F. Rudzin, Asher Rivner, O‘MELVENY & MYERS LLP, New York, New York; Attorneys for Defendants Gregory B. Maffei, Albert E. Rosenthaler, Larry E. Romrell, J. David Wargo, Michael J. Malone, Chris Mueller, Christy Haubegger, and Nominal Defendant Liberty TripAdvisor Holdings, Inc.
Bradley R. Aronstam, S. Michael Sirkin, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; John A. Neuwirth, Evert J. Christensen, Jr., Stefania D. Venezia, WEIL, GOTSHAL & MANGES LLP, New York, New York; Attorneys for Defendants Matt Goldberg, Jay C. Hoag, Betsy Morgan, Greg O‘Hara, Jeremy Philips, Trynka Shineman Blake, Jane Jie Sun, and Robert S. Wiesenthal, and Nominal Defendant TripAdvisor, Inc.
LASTER, V.C.
A Delaware corporation has two classes of stock. The CEO/Chair owns high-vote shares carrying a majority of the outstanding voting power, giving him hard majority control. The board decides to convert the Delaware corporation into a Nevada corporation, and the CEO/Chair delivers the necessary stockholder vote. The board does not establish any protections to simulate arm‘s length bargaining. The conversion is not conditioned on either special committee approval or a majority-of-the-minority vote.
A stockholder plaintiff challenges the conversion.1 The plaintiff argues that Nevada law offers fewer litigation rights to stockholders and provides greater litigation protections to fiduciaries like the directors and the CEO/Chair. The plaintiff alleges that the directors and the CEO/Chair approved the conversion to secure the litigation protections for themselves. In support of those assertions, the plaintiff cites the materials the board considered, disclosures in the company‘s proxy statement, the work of distinguished legal scholars about the content of Nevada law, and public statements by Nevada policy makers about the direction Nevada law has taken.
The defendants move to dismiss the complaint, arguing that it fails to state a claim on which relief can be granted. The outcome depends in the first instance on the standard of review.
As depicted, the conversion constitutes a self-interested transaction effectuated by a stockholder controller. The reduction in the unaffiliated stockholders’ litigation rights inures to the benefit of the stockholder controller and the directors. That means the conversion confers a non-ratable benefit on the stockholder controller and the directors, triggering entire fairness. There are no protective devices that could lower the standard of review. Entire fairness governs.
With entire fairness as the operative standard of review, the plaintiff has stated a claim on which relief can be granted. The entire fairness standard has two dimensions:
The floor for substantive fairness is whether stockholders receive at least the substantial equivalent in value of what they had before. Before the conversion, the stockholders held shares carrying the bundle of rights afforded by Delaware law, including a set of litigation rights. After the conversion, the stockholders owned shares carrying a different bundle of rights afforded by Nevada law, including a lesser set of litigation rights. That makes it reasonably conceivable that the stockholders do not possess at least the substantial equivalent of what they possessed before, supporting an inference that the conversion was not substantively fair.
The test for procedural fairness is whether the process leading to the conversion adequately simulated arm‘s length bargaining. As depicted, the stockholder controller and the board did not implement any procedural protections. The board recommended the conversion, and the stockholder controller delivered the vote. Those allegations support an inference that the conversion was not procedurally fair.
The plaintiff therefore has stated a claim on which relief can be granted. That holding does not require finding that Nevada provides greater protection against fiduciary liability than Delaware law. The question at this stage is whether it is reasonably conceivable that Nevada law offers greater protection. The complaint alleges facts suggesting that it does, that the defendants think so too, and that the defendants sought to capture those benefits for themselves through the conversion. This decision must credit the complaint‘s allegations.
Holding that the plaintiffs have stated a claim on which relief can be granted does not discriminate against Nevada entities. The same reasoning would apply if a Delaware corporation converted into another Delaware entity in a transaction with comparable implications. Using the contractual freedom conferred by the Delaware Limited Liability Company Act, entity planners can implement a wide array of governance schemes that provide fewer rights to investors than what stockholders in a Delaware corporation enjoy. If a Delaware corporation converted into a Delaware LLC where the governing agreement had eliminated all fiduciary duties, then the same reasoning would hold. Entity planners could even design a Delaware LLC that mirrors the internal governance structure of a Nevada corporation. If a Delaware corporation converted into that LLC, the outcome would be the same.
Holding that these plaintiffs have stated a claim on which relief can be granted does not mean that corporations cannot leave Delaware. The plaintiffs have asked for an injunction to block the company‘s departure, but even on the facts alleged, it is not reasonably conceivable that the court would enjoin the company from leaving.
Nor does this decision mean that a corporation can never leave Delaware without litigation risk. If a board proposed a similar conversion for a corporation without a stockholder controller, and if the fiduciaries fully disclosed the consequences of the change in legal regimes, including the effect on stockholder litigation rights, then the stockholders’ approval of the conversion would be dispositive, triggering an irrebuttable version of the business judgment rule.2 If directors proposed a similar conversion for a corporation with a stockholder controller, and if they properly conditioned the transaction on the twin MFW protections, then the dual approvals would
The plaintiffs can only state a claim on which relief can be granted because (1) the corporation has a stockholder controller, and (2) the board did not implement any protective provisions. The defendants also did not make any effort to compensate the stockholders for the reduction in their litigation rights. Change any of those variables and the outcome could be different.
Instead, the outcome reflects that fiduciary duties operate unremittingly, as the Delaware Supreme Court has repeatedly held.4 That includes when fiduciaries effectuate a transaction that will eliminate the protection of Delaware law.
The outcome rests on a sound policy foundation. Delaware strives to maintain a balanced corporation law that protects the interests of both managers and investors. Delaware law gives managers broad discretion to build businesses, take risks, and create value. At the same time, Delaware law protects investors through a combination of statutory provisions and common law fiduciary duties. Because of those protections, investors willingly entrust their capital to Delaware corporations.
If the business judgment rule applied in this setting, then a stockholder controller could reduce the rights investors enjoy by changing the corporation‘s domicile. That would create a gap in the protections offered by Delaware law. The gap would have knock on effects, and investors would demand greater returns ex ante to compensate for the increased risk. The cost of capital for Delaware corporations would go up.
By applying fiduciary duties consistently across all controller transactions, Delaware prevents gaps from forming in its law. A stockholder controller can exit Delaware on fair terms. If the controller does not establish the MFW protections up front, then the controller must prove entire fairness. Stockholders receive compensation for their lost rights, and the controlled company can carry on in a new jurisdiction.
Here, the defendants did not establish the MFW protections up front, and they will bear the burden of proving entire fairness.
I. FACTUAL BACKGROUND
The facts are drawn from the plaintiffs’ complaint and the documents that it incorporates by reference.5
A. The Defendants
TripAdvisor, Inc. (“TripAdvisor” or the “Company“) is a Delaware corporation that operates the world‘s largest travel guidance platform. It has a dual-class capital structure. The Class A common stock carries one vote per share and trades publicly under the symbol “TRIP.” The Class B common stock carries ten votes per share and is owned exclusively by Liberty TripAdvisor Holdings, Inc. (“Holdings“). In addition to owning all of the Company‘s Class B shares, Holdings owns approximately 21% of the Class A shares. Through that stake, Holdings exercises 56% of the Company outstanding voting power while owning barely one fifth of the economic interest.
Holdings has a dual-class capital structure of its own. Its Series A common stock carries one vote per share, and its Series B common stock carries ten votes per share. Both series trade publicly.
Gregory B. Maffei is the CEO and Chairman of Holdings. When the plaintiffs filed this action, Maffei beneficially owned Series B shares carrying 43% of Holdings’ voting power. For purposes of their motion to dismiss, the defendants concede that Maffei controls both Holdings and TripAdvisor.
The other defendants are members of either the Company‘s board of directors (the “Company Board“) or Holdings’ board of directors (the “Holdings Board“). The members of the Company Board are Maffei, Matt Goldberg, Jay C. Hoag, Betsy Morgan, Greg O‘Hara, Jeremy Philips, Albert E. Rosenthaler, Trynka Shineman Blake, Jane Jie Sun, and Robert S. Wiesenthal. The members of the Holdings Board are Maffei, Rosenthaler, Larry E. Romrell, J. David Wargo, Michael J. Malone, Chris Mueller, and Christy Haubegger.
B. The Company Board Resolves To Convert TripAdvisor Into A Nevada Corporation.
At a meeting in November 2022, TripAdvisor management first presented to the Company Board about the possibility of converting TripAdvisor into a Nevada corporation. They benefits included greater protections against litigation for directors and officers, plus lower franchise taxes and fees.
In February 2023, the Company Board revisited the potential conversion. A management presentation noted that the “laws of Nevada would generally permit the Company to offer greater protection to its directors and officers” and reduce the “risk of expensive and time consuming litigation against the Company and its directors and officers.” DX 2 at ‘059. The presentation included a comparison of Delaware and Nevada law and explained that under Nevada law, a director or officer can be liable “only when the plaintiff affirmatively rebuts the business judgment presumption and demonstrates that the fiduciary breach involved intentional misconduct, fraud, or a knowing violation of law.” Id. at ‘063. The presentation explained that Delaware law applied the entire
In March 2023, the Company Board again considered whether TripAdvisor should become a Nevada entity. A management presentation again noted that Nevada law generally offered greater protection against liability to officers and directors. DX 3 at ‘090.
At the end of the March meeting, the Company Board unanimously resolved to approve the conversion of the Company into a Nevada corporation. At a meeting in April 2023, the Company Board approved final resolutions authorizing the conversion.
C. The Holdings Board Resolves To Convert Holdings Into A Nevada Corporation.
During March 2023, Holdings management presented to its directors on potentially converting into a Nevada corporation. The presentation identified the following advantages:
- “Recent case law developments in Delaware, in particular with respect to conflicted controller and ‘change of control’ transactions, have increasingly emboldened plaintiffs’ law firms to bring claims against directors and officers, significant stockholders and the company and have increased potential exposure for these parties[.]”
- “Under Delaware law director liability cannot be eliminated if the court finds a breach of duty of loyalty and D&O carriers often argue duty of loyalty claims are not insured[.]”
- “Cases that are subject to ‘entire fairness’ review in Delaware (which requires the defendants to demonstrate that the price and process in a transaction were entirely fair) present a high bar and, because of the factual issues involved, it is often difficult for defendants to prevail in the preliminary stages of litigation[.]”
- “Liberty Media [an affiliated public company for which Maffei serves as CEO], its service companies and certain of their portfolio companies have experienced these developments, having been involved in at least 8 stockholder lawsuits in Delaware since 2012 (5 of which were brought in the last 5 years) which have resulted in substantial time and expense to defend and resolve[.]”
- “Management believes Nevada law generally provides greater protection from liability to the Company and its D&Os than Delaware law[.]”
- “Nevada law eliminates the individual liability of both officers and directors to the company, its stockholders or its creditors for damages as a result of a breach of fiduciary duty unless the breach involved intentional misconduct, fraud or a knowing violation of law and unless a company‘s articles of incorporation provide for greater liability[.]”
- “Nevada does not follow Revlon duties (duty to get the best price reasonably available in a sale), and instead permits consideration of ‘other constituencies’ by statute[.]”
DX 5 at ‘013, ‘016. Management undertook to explore the idea further and report back to the directors at a later date.
In April 2023, management circulated additional information about the conversion process. The members of the Holdings Board approved the conversion by unanimous written consent.
The Company and Holdings sought stockholder approval for the conversions. They prepared and distributed proxy statements asking stockholders to vote in favor.
The Company‘s proxy statement called the conversion a “Redomestication.” Under the heading “Reasons for the Redomestication,” the proxy statement disclosed the following:
- “[T]he Redomestication will provide potentially greater protection for unmeritorious litigation for directors and officers of the Company.”
- “The Redomestication will result in the elimination of any liability of an officer or director for a breach of the duty of loyalty unless arising from intentional misconduct, fraud, or a knowing violation of law.”
- “[W]e believe that, in general, Nevada law provides greater protection to our directors, officers, and the Company than Delaware law.”
DX 10 at 29.
The Holdings proxy statement offered similar rationales. Under the heading “Reasons for the Conversion,” the Holdings proxy statement disclosed the following:
- “We believe that . . . Nevada law generally provides greater protection against liability for our directors, officers and the company than Delaware law.”
- “The conversion will therefore result in the elimination of liability of an officer or director for breaches of fiduciary duties to the company, including its stockholders unless, [sic] involving intentional misconduct, fraud or knowing violation of law.”
DX 9 at 40.
At stockholder meetings in June 2023, holders of a majority of the voting power at each company approved each conversion. Assuming Holdings cast all of its votes in favor the Company conversion, only 5.4% of the unaffiliated Company stockholders voted in favor. Assuming Maffei cast all of his votes in favor of the Holdings conversion, only 30.4% of the unaffiliated Holdings stockholders voted in favor. Holdings and Maffei thus provided the decisive votes.
E. This Litigation
In April 2023, the plaintiffs filed this action. Herbert Williamson alleges that he is a stockholder of Holdings. Dennis Palkon alleges that he is a stockholder of TripAdvisor. They contend that the conversions were self-interested transactions that are not entirely fair.
The complaint sought an injunction to prevent the conversions from closing. The defendants agreed not to effectuate the conversions unless the parties otherwise agree or the court enters an order dismissing the case that has become final.
F. Late-Breaking News
On February 9, 2024, the Company announced that it had entered into discussions with Holdings about a going-private transaction and had formed a special committee to oversee those discussions. The announcement stated that any transaction would be subject to the twin MFW protections. There was no assurance as to whether an agreement might be reached or when a going-private transaction might happen.
The court asked the parties whether the announcement had implications for the motion
II. LEGAL ANALYSIS
The defendants have moved for dismissal under Rule 12(b)(6). When considering such a motion, the court (i) accepts as true all well-pled factual allegations in the complaint, (ii) credits vague allegations if they give the opposing party notice of the claim, and (iii) draws all reasonable inferences in favor of the plaintiffs. Dismissal is inappropriate “unless the plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances.”6
A. Statutory Compliance And The Twice-Tested Framework
The defendants launch their argument for dismissal by explaining that the conversions complied with Section 266 of the Delaware General Corporation Law (the “DGCL“), which authorizes “[a] corporation of this State [to] . . . convert to . . . a foreign corporation.”7 A conversion historically required both a board recommendation and unanimous stockholder approval. In 2022, the General Assembly amended the statute to require a board recommendation and approval from holders of a majority of the corporation‘s outstanding voting power.8
Assuming the defendants are right about statutory compliance, that does not end the inquiry. “[I]nequitable action does not become permissible simply because it is legally possible.”9 Instead, according to Professor Berle‘s famous formulation,
in every case, corporate action must be twice tested: first, by the technical rules having to do with the existence and proper exercise of the power; second, by equitable rules somewhat analogous to those which apply in
favor of a cestui que trust to the trustee‘s exercise of wide powers granted to him in the instrument making him a fiduciary.10
“A reviewing court‘s role is to ensure that the corporation complied with the statute and [that its fiduciaries] acted in accordance with [their] fiduciary duties.”11
B. The Claim For Breach Of Fiduciary Duty
The real question is whether the complaint states a claim for breach of fiduciary duty. Analyzing that claim requires determining the appropriate standard of review, then evaluating the allegations through that lens. That analysis reveals that the plaintiffs have stated a claim on which relief can be granted.
1. The Standard Of Review
“Delaware has three tiers of review for evaluating director decision-making: the business judgment rule, enhanced scrutiny, and entire fairness.”12
Delaware‘s default standard of review is the business judgment rule. When applying that standard, a court presumes that the defendant fiduciaries “acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”13 Unless a plaintiff rebuts one of the elements of the rule, “the court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation‘s objectives.”14 Only when a decision lacks any rationally conceivable basis will a court infer bad faith and a breach of duty.15
Enhanced scrutiny is “Delaware‘s intermediate standard of review.”16 Enhanced scrutiny synthesizes the lessons from a series of 1980s decisions, when standards of review seemed to proliferate.17 Each of the 1980s precedents bore two hallmarks. First, there was a specific, recurring, and identifiable context where the realities of the situation could subtly undermine the decisions of even independent and disinterested directors. Second, the action the directors took intruded into a space where stockholders possess rights
Each time a decision addressed one of those situations, the court applied an intermediate standard of review that examined “the reasonableness of the end that the directors chose to pursue, the path that they took to get there, and the fit between the means and the end.”21 Under this standard, the directors must establish that they (i) sought to pursue a legitimate end and (ii) selected an appropriate means of achieving it. It is not enough for the directors to have a good faith belief that a
particular outcome is desirable; they must have a reasonable basis for their belief. It is also not permissible for the directors to pursue the desired outcome by any means necessary. They must select a means that falls within a range of reasonableness.
Delaware‘s most onerous standard is entire fairness. Under that standard, the fiduciary defendants must establish “to the court‘s satisfaction that the transaction was the product of both fair dealing and fair price.”22 “Not even an
The defendants contend that the business judgment rule protects the conversions. But since 1994 (if not before), Delaware law has deemed the business judgment rule rebutted and applied the entire fairness test ab initio to any transaction between the corporation and a controlling stockholder in which the controller receives a non-ratable benefit.24 Unless the transaction incorporates one or more protective mechanisms, “the standard of review for that decision is entire fairness, with the burden of proof resting on the defendants.”25
Plaintiffs allege—and for purposes of this motion, defendants concede—that Maffei controls both Holdings and the Company. No one suggests that the conversions were cleansed in any way. Determining the correct standard of review therefore depends on whether the conversions conferred a non-ratable benefit on the fiduciary defendants.
2. Non-Ratable Benefits
Under Delaware law, a controller or other fiduciary obtains a non-ratable benefit when a transaction materially reduces or eliminates the fiduciary‘s risk of liability. Delaware decisions have applied that principle repeatedly to mergers.26 The parties posit that no Delaware decision has applied those principles to a reincorporation merger, but that is not so. In Harris v. Harris, the court explained that Mary Ellen Harris, the sole director of a privately held, family-run corporation was interested in a reincorporation merger that moved the corporation‘s domicile from Delaware to New Jersey and, in the process, extinguished the minority
stockholders’ standing to pursue derivative claims.27 Those claims sought “to recover compensation and benefits paid to Mary Ellen and the Advisors, making them interested in the litigation.”28 Because the merger extinguished the plaintiffs’ standing to pursue those claims, the defendants received a non-ratable benefit from the reincorporation
In response, the defendants contend that a fiduciary can only receive a material benefit from a reduction in liability exposure if the transaction addresses “existing potential liability.”30 By using that oxymoronic phrase, they mean a situation where the events giving rise to the claim have already occurred, making the liability “existing,” even if a judgment has not yet been entered, making the liability “potential.” The alternative to “existing potential liability” is “future potential liability,” where the events that could give rise to liability have not happened yet.31
The defendants’ arbitrary distinction between existing potential liability and future potential liability would make Delaware law piteously naive. Real-world actors have no difficulty understanding that litigation risk can exist even though the specific events have not happened yet. Delaware law can too.
Insurance premiums present a multi-trillion dollar problem for the defendants’ distinction. When a policy issues, none of the events that could give rise to a claim have happened yet. In the defendants’ parlance, all of the insured‘s potential losses are future potential liabilities, not existing potential liabilities. But that does not undermine the policy‘s value. The market for insurance exists because humans understand the importance of mitigating risk for future potential liabilities. Obtaining coverage for future potential liabilities is a benefit, and insureds pay premiums to get it.
Think about whether a change in coverage for future potential liabilities might matter to an insured. For any given level of coverage, its real value to the insured depends on the conditions that the insured must meet to make a successful claim. All else equal, a policy with greater conditionality has less value, because it will be more difficult for the insured to recover. An insured does not get as much benefit from the same dollar value of coverage if onerous conditions make recovery less likely. Conversely, an insurer gets greater benefit from the same dollar value of premium if onerous conditions mean the insurer is less likely to pay.
Now imagine an insurer that can ratchet up the conditions for coverage at will (either through express changes or by applying
The insurance example maps onto this case. Corporate law gives stockholders the right to recover from their fiduciaries for certain types of wrongdoing. Stockholders do not pay insurance premiums to secure that right; it exists because of the principles of equity that govern fiduciary behavior.32 If the law changes such that recovery becomes more difficult, then the right to pursue the recovery has less value.
In insurance terms, the fiduciaries are less likely to pay. As with the insurance policy, the change imposes a detriment on stockholders and confers a benefit on the fiduciaries. It does not matter that the events that could give rise to a claim have not happened yet.33
The arbitrary nature of the existing-potential versus future-potential distinction shines through for other stockholder rights as well. Assume that a transaction alters an economic right, such as the right to receive dividends when and if declared by the board. Envision that before the transaction, each share of stock carries the right to receive a pro rata portion of any dividend declared by the board, but that after the transaction, each share only carries the right to receive a pro rata portion of any dividend declared by the board if that share is held by a director. Under the defendants’ approach, that change could confer a benefit on the insiders only if the transaction took place after the board declared a dividend and before it was distributed, because only then would there be an existing-potential opportunity to receive the dividend. Yet it is easy to see that the change reallocates economic value regardless of whether an existing dividend has been declared. The reallocation might only affect future-potential dividends, but that provides little comfort to the unaffiliated stockholders. Their share of any future dividend will go to the insiders. That is a non-ratable benefit to the insiders, even though the benefit will manifest itself tangibly from future-potential dividends rather than an existing-potential dividend.
Moving from litigation claims to economic rights points to another multi-trillion-dollar problem for the defendants’ theory: the options market. Envision a standard American call option to purchase a share of common stock with the strike price set at the market price on the grant date. The
Using defendant‘s concepts, the call option has no value. As they see it, only existing-potential value matters, and the call option has none of that because none of the states of the world in which the call option has intrinsic value have occurred. Yet we know people value that type of option. Just ask executives and employees who demand them as part of their compensation packages. Deeply out-of-the-money options and futures reveal the concept even more clearly. Derivatives covering trillions of dollars in notional value exist because parties care about future-potential events.
The defendants’ distinction is therefore hard to follow. It also lacks persuasive support in case law. To justify their fixation on existing potential liability, the defendants rely primarily on four cases: Bamford,34 Orloff,35 Coates,36 and Sylebra.37 They cite Chevron38 and Underbrink39 in passing.
Read together, those cases do not support a temporal distinction. They support a materiality rule. To be fair, some of the cases use temporal language, but the real pivot is materiality. That should not be surprising. A fiduciary is interested in a transaction when it confers a material benefit on the fiduciary.40 The cases treat litigation protection as a benefit and ask whether the reduction in litigation risk is material.
The Bamford litigation involved a closely held LLC with three members. One of the members—Joseph Manheim—held a majority of the member interests. Manheim and a second member worked for the LLC; the third was a passive investor. After Manheim fired the other working member, souring that relationship, the passive member became suspicious about Manheim‘s actions. Anticipating litigation, Manheim adopted a new LLC agreement that contained an “impressively broad exculpatory provision.”41 Manheim sought to
When the other members filed suit, Manheim invoked the exculpation provision. The court held that adopting the provision was “a self-interested decision that can be reviewed in equity.”43 Entire fairness applied because the provision reduced Manheim‘s litigation exposure, and he had not attempted to show that the provision was entirely fair. The court therefore held that the provision was ineffective. In reaching this conclusion, the court found that “[i]t was not equitable for Manheim to implement the [provision] unilaterally in an effort to eliminate all liability, prospectively and retrospectively, for any fiduciary breach.”44
Bamford did not distinguish between existing-potential and future-potential liability. That adoption of the exculpatory provision was plainly material, rendering Mannheim interested. The Bamford decision does not support a temporal rule. It supports a materiality rule.
The same is true with Orloff. There, the individuals who controlled a corporation adopted a Section 102(b)(7) provision after minority stockholders had filed a books-and-records action. In subsequent plenary litigation, the plaintiffs alleged that the defendants approved the provision “under the threat of imminent litigation, and breached their fiduciary duties by self-interestedly protecting themselves against litigation that they knew would soon name them as defendants.”45 The court dismissed the claim, finding that the plaintiffs failed to adequately allege “facts creating a reasonable doubt that the directors were disinterested or independent when they made their decision to approve the certificate amendment.”46
In Decker, the plaintiff asserted what today would be recognized as a Caremark claim, and the defendants moved to dismiss under Rule 23.1. The plaintiff argued that the directors faced a substantial risk of personal liability that prevented them from considering a demand disinterestedly because “insurance would not cover an action brought by the company against its own directors” and alleged that the directors necessarily feared the lawsuit because they had recommended the adoption of a Section 102(b)(7) provision. 1989 WL 133617 at *2. The Decker court dismissed the Caremark claim because demand was not futile. The case did not involve a challenge to the exculpatory provision itself.
Likewise in Caruana, the plaintiffs asserted a derivative claim challenging the sale of a subsidiary to certain insiders. The defendants moved to dismiss under Rule 23.1. As in Decker, the plaintiffs argued that the defendants faced a substantial risk of personal liability that prevented them from considering a demand disinterestedly because “liability insurance would not cover an action brought by the company against its own directors,” and they alleged that the directors were concerned about the lawsuit because “the directors recommended a charter amendment limiting their liability.” 1990 WL 212304, at *3. The court cited Decker to hold that those allegations were insufficient to establish interestedness and did not analyze the issue further. Id. at *4.
There is a difference between (i) arguing that directors are interested in the
In the vast majority of cases, there is no valid fiduciary challenge to the adoption of a Section 102(b)(7) provision because stockholders approve it. Williams v. Geier, 671 A.2d 1368, 1381 (Del. 1996). The fiduciary duty issue arises when the directors who recommend the provision also deliver the vote. That was the case in Orloff, but the court did not focus on that question. In a later decision involving the same issue—the adoption of an exculpatory provision by a controller—the court treated the challenge to the provision as settled by Caruana, Decker, and Orloff. Sutherland v. Sutherland, 2010 WL 1838968, at *14–15 (Del. Ch. May 3, 2010). In reality, no Delaware decision has directly confronted the question.
prospectively.47 The Orloff court thus could readily conclude that the Section 102(b)(7) provision did not confer a material benefit on the fiduciaries who adopted it. The Orloff decision also rejected a complaint that was generalized and conclusory.48 Read properly, the Orloff supports a materiality rule as well.
The Coates case likewise points to a materiality rule. A stockholder plaintiff challenged a reincorporation merger, but with the corporation moving from California to Delaware. In the proxy statement, the board acknowledged that “Delaware law provided more protections for the board” and cautioned that stockholders should take that conflict of interest into account when considering their recommendations.49 After the merger closed, a stockholder filed suit in Delaware. The plaintiff primarily raised disclosure violations, but also argued that the directors were interested in the merger due to Delaware‘s more favorable law. After rejecting the alleged disclosure violations, Chancellor Chandler held that the complaint did not sufficiently plead any facts suggesting interestedness. He did not reject the idea that directors could be interested in a transaction that conferred greater legal protections.50 He instead held that the plaintiff had not sufficiently pled self-interested conduct based solely on the directors’ acknowledgment that “a possible conflict of interest may arise from the greater protections afforded directors under Delaware law.”51 The Chancellor declined to credit what he regarded as a “mere conclusory statement” with no supporting factual predicate.52 The plaintiff thus failed to allege facts supporting an inference that the merger conferred a material benefit on the directors.
In passing, the defendants cite Chevron and Underbrink. They suggest that the Chevron court considered whether a forum-selection bylaw created a disqualifying interest, but that is not accurate. The case involved a facial challenge to the validity of a forum-selection bylaw, and in the section the defendants cite, the court declined to consider as-applied challenges based on whether the bylaw might operate unreasonably in future cases.55 The defendants have taken language out of context. Regardless, for a Delaware corporation to use a forum-selection bylaw to concentrate internal affairs litigation in Delaware court would not confer a material benefit on its fiduciaries. The bylaw only changes the forum, not the law or the fiduciaries’ litigation exposure. To the extent that plaintiffs might be able to secure greater recoveries in other forums, that is not due to differences in substantive law, but rather the increased volatility that results when courts apply law with which they are less familiar.56 Concentrating cases in Delaware thus does not reduce litigation exposure relative to what outcomes should be, meaning that the forum-selection bylaw does not confer any benefit, much less a material one.
The last decision—Underbrink—held after trial that entire fairness would not apply to a board‘s decision to adopt a mandatory advancement bylaw where the benefit conferred was not material.57 The Underbrink decision interpreted Orloff as supporting a temporal distinction and put heavy emphasis on that concept when assessing materiality. But the ultimate question for purposes of rebutting the business judgment rule was materiality, not temporal orientation.
The real question for determining the standard of review is whether a decision confers a material benefit on the fiduciaries who made it. Here, it is reasonable to infer at the pleading stage that the conversions will confer a material benefit on the fiduciary defendants who approved them. The defendant directors focused on the ability of the conversions to reduce or eliminate litigation risk. The board materials
During the hearing on the motion to dismiss, the defendants seemed to acknowledge that materiality is what matters, because their counsel sought to argue that Nevada law—properly understood—is not more protective than Delaware law. This decision does not rule on that issue. At the pleading stage, it is reasonable to infer from the complaint‘s allegations that Nevada law provides greater protection to fiduciaries and confers a material benefit on the defendants. To the extent the defendants wish to show that Delaware law and Nevada law are equivalent, they can attempt to make that showing at a later phase of the case. The plaintiffs have alleged particularized facts demonstrating that the defendants were interested in the conversions. Entire fairness therefore applies.
3. The Feasibility Of Applying The Entire Fairness Standard
The defendants separately argue that entire fairness cannot supply the standard of review because the court cannot feasibly apply that standard outside of a transaction in which stockholders received cash for their shares. They ask rhetorically, “how would the Court even conduct an entire fairness review, where there is no ‘price’ to be assessed for fairness?”58 That objection misunderstands the entire fairness test.
Entire fairness is a unitary standard that has both substantive and procedural dimensions. Although the two aspects may be examined separately, they are not separate elements of a two-part test. “All aspects of the issue must be examined as a whole since the question is one of entire fairness.”59
The substantive dimension of the fairness inquiry examines the transactional result. The cases that developed the entire fairness test historically involved freeze-outs or squeeze-outs. The earliest freeze-outs involved corporations selling all of their assets for a package of consideration, typically cash, then dissolving and distributing the net cash to stockholders.60 After mergers became the preferred transactional vehicle, the leading cases involved squeeze-outs in which the minority shares were converted into the right to receive a specific amount of cash.61 The substantive fairness of the transaction therefore largely turned on the price that the minority stockholders received, and “fair price” became the dominant nomenclature for the substantive dimension. In that setting, the fair price inquiry generally involved comparing what the stockholders received with their proportionate share of the corporation‘s value as a going concern. Thus, in the canonical framing, fair price “relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company‘s stock.”62 But the substantive dimension of the entire fairness inquiry has never been narrowly focused
The procedural dimension of the entire fairness inquiry examines the process that generated the result. Known as “fair dealing,” it “focuses upon the conduct of the corporate fiduciaries in effectuating the transaction.”64 The procedural dimension “embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.”65
The procedural dimension matters because the substantive dimension is often contestable. “The concept of fairness is of course not a technical concept. No litmus paper can be found or [G]eiger-counter invented that will make determinations of fairness objective.”66 Instead, a judgment concerning fairness “will inevitably constitute a judicial judgment that in some respects is reflective of subjective reactions to the facts of a case.”67 Thus, if fiduciaries successful replicate arm‘s length bargaining, then that that evidence of fair dealing can validate a debatable outcome. But the opposite is also true: a dubious process can call into question a low but nominally fair price.68 “Factors such as coercion, the misuse of confidential information, secret conflicts, or fraud could lead a court to hold that a transaction that fell within the range of fairness was nevertheless unfair compared to what faithful fiduciaries could have achieved.”69 Where those factors are present, a court
may conclude that the transaction is not entirely fair. As a remedy, the court could award a “fairer price”70 or rescissory damages.71
- In Nixon v. Blackwell, the controlling stockholders of E.C. Barton & Co. generated liquidity for themselves and select company employees by using an employee stock option plan and key man life insurance policies to repurchase shares. The minority stockholders were not eliminated for a specific price per share, yet the Delaware Supreme Court applied the entire fairness test.73
- In Trans World Airlines, a corporation purchased or leased aircraft from its controlling stockholder. Those transactions were not freeze-outs or squeeze-outs and there was no cash price per share, yet the Delaware Supreme Court applied the entire fairness test.74
- In Tremont I, Tremont Corporation purchased 15% of the stock of NL Industries, Inc. from Valhi, Inc. When the transaction took place, Harold Simmons controlled all three corporations. The transaction did not have an obvious per-share price, but both Chancellor Allen and the Delaware Supreme Court applied the entire fairness test.75
- In T. Rowe Price, Seaman Furniture Company entered into a services agreement with another company owned by Seaman‘s controlling stockholder. Seaman agreed to manage stores and provide operational expertise to the company in return for a multi-million dollar annual fee. The transaction did not involve stockholders receiving a specific price per share, but Vice Chancellor Lamb applied the entire fairness test.76
- In Harbor Finance Partners, a company repurchased a block of its notes from its controlling stockholder. The transaction was not a freeze-out or squeeze-out involving a specific price per share, but Justice Jacobs, then a
Vice Chancellor, applied the entire fairness test.77
Many more examples exist.78
Taken to its logical extreme, the defendants’ argument would mean that a court could not apply entire fairness in a stock-for-stock merger, because there is no dollars-and-cents price. Yet the Delaware courts have applied the entire fairness test to parent-subsidiary mergers in which the minority shares were converted into the right to receive stock.79 Not only that, but the defendants’ argument logically means that a Delaware court cannot conduct an appraisal after a stock-for-stock merger. The fair price analysis and the fair value analysis involve parallel inquiries,80 so if a court cannot analyze the entire fairness of stock-for-stock merger due to the lack of a per-share price, then a court cannot conduct an appraisal either. Yet theIn substance, the two conversions in this case operate like stock-for-stock mergers in which stockholders in the Delaware corporations have their shares converted into the right to receive shares of Nevada corporations. If the Company‘s and Holdings’ shares did not trade publicly, bringing them within the market-out exception, then the stockholders would have appraisal rights.82 The court could not shirk an appraisal inquiry, which the
4. Evidence Of Unfairness
When entire fairness is the standard of review, and when a plaintiff “alleges facts making it reasonably conceivable that the transaction was not entirely fair to stockholders, the granting of a motion to dismiss is inappropriate, because the burden is on the defendants to develop facts
The plaintiffs have pled facts sufficient to call into question the substantive dimension of fairness, because the stockholders will not receive the substantial equivalent of what they had before. When the Company and Holdings were Delaware corporations, the unaffiliated stockholders enjoyed all of the litigation rights provided by Delaware law. After the conversion, the unaffiliated stockholders will possess only the litigation rights provided by Nevada law. For the reasons already discussed, those litigation rights are inferably less than what Delaware provides.
The plaintiffs also have pled facts sufficient to call into question the procedural dimension of fairness. The goal of procedural fairness is to replicate arm‘s length bargaining. The defendants did not make any effort to replicate arm‘s length bargaining. Management proposed the conversions, the Board recommended them, and Holdings and Maffei approved them.
The unaffiliated stockholders’ voting pattern supports an inference of unfairness. Just as an informed vote by unaffiliated stockholders in favor of a conflicted transaction is evidence of fairness,85 an informed vote by unaffiliated stockholders against a conflicted transaction suggests unfairness. Here, the unaffiliated stockholders resoundingly rejected the conversions.
The defendants observe that in Williams v. Geier,86 a majority of the Delaware Supreme Court considered a challenge to a charter amendment that adopted a tenured voting structure. A family group that held a majority of the shares approved the amendment without a majority of the minority vote. Three-quarters of the minority shares were present at the meeting, and two-thirds of those shares voted in favor, but enough of the minority shares did not participate that the amendment failed to secure support from a majority of the minority.87 The plaintiffs pointed to that fact as evidence of unfairness, but the Delaware Supreme Court disagreed:
Where, as here, there is a controlling stockholder or a controlling bloc, there is no requirement under the Delaware General Corporation Law that the transaction be structured or conditioned so as to require an affirmative vote of a majority of the minority group of outstanding shares. In those parent-subsidiary situations where the circumstances call for an entire fairness analysis, the burden is normally on the defendants to show entire fairness, but if a majority of the minority votes in favor under certain circumstances, the burden shifts to the plaintiff to show unfairness. The converse does not apply, however—namely, the failure to obtain a majority of the minority does not give rise to any adverse inference of invalidity.88
The Williams decision predated by almost two decades the decisions in MFW, Corwin, and C&J Energy that stressed the importance of informed stockholder voting
The defendants contend that other benefits of Nevada incorporation render the conversion fair, such as lower franchise taxes and a greater ability to recruit management personnel. The reduction in franchise taxes appears immaterial given the size of the Company and Holdings. The greater ability to recruit management personnel seems to be a function of reduced litigation exposure, so it is not really a separate benefit. Regardless, those allegedly countervailing benefits cannot be assessed at this stage.
The plaintiffs have alleged facts supporting a reasonable inference that the conversions are not entirely fair. The complaint therefore states a claim on which relief can be granted.
C. Preventing Litigation Rights From Becoming Second-Class Rights.
Holding that the plaintiffs have stated a claim in this action fulfills important public policies related to Delaware‘s effort to maintain a balanced legal regime. As discussed previously, Delaware strives to gives substantial discretion to managers to build businesses and create value while at the same time offering protections to investors so that they willingly contribute
Stockholders are widely regarded as possessing three fundamental rights: to sell, vote, and sue.91 Each fundamental right represents a category of entitlements that stockholders possess: economic rights, governance rights, and litigation rights.92
It seems readily apparent that under current Delaware law, a transaction that cuts back on either economic rights or governance rights would trigger entire fairness review. Envision a scenario in which the Company merges with another Delaware corporation, the high-vote shares are converted into identical high-vote shares of the resulting corporation, and the low-vote shares are converted into nearly identical low-vote shares of the resulting corporation—the sole difference being that the new shares are subject to a redemption right. Assume the resulting corporation can exercise the redemption right at any time and from time to time to buy in low-vote shares at a 20% premium to the pro rata value of the Company at the effective time. Because Maffei, through Holdings, controls the resulting corporation, he can decide whether and when to redeem the low-vote shares. If the value of the corporation appreciates by more than 20%, he can exercise the redemption right. The corporation would capture the incremental value, but because Holdings’ ownership percentage would increase, Maffei benefits. It seems obvious that the merger would be an interested transaction, implemented by a stockholder controller, in which the stockholder controller receives a non-ratable benefit. Entire fairness would govern.
Now forget the redemption right. Assume the merger converts the Company‘s low-vote shares into no-vote shares. The answer still seems obvious. The loss of voting power inures to Holdings’ benefit. Before the merger, only a long-form squeeze-out was possible. After the merger, a short-form squeeze-out is on the table, which changes the game for the unaffiliated holders.93 The merger is therefore a self-interested one, and entire fairness again would govern.
The same should be true for litigation rights. They are not second-class rights. They enable parties to access the courts, which is foundational to a civil society and necessary to protect all other rights.
Without the ability to obtain a judgment from a court, backed by the power of the state, other rights become meaningless. Unless the holder of the right has some other source of leverage, like influence, economic power, or a willingness to deploy extra-legal force, then the counterparty can ignore the right. Without
courts to enforce them, even voting rights can become nullities. In a civil society, what renders a right meaningful is access to the courts and, with a judgment in hand, the power of the state.94
Value ultimately depends on legal rights, 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.”95 Economic rights and governance rights remain meaningful only to the extent that litigation rights back them up. Without legal protection, an investor‘s capital becomes a gift.
From the perspective of equity, Delaware law should be just as concerned about transactions that reduce stockholders’ litigation rights as it is about transactions that reduce their economic rights or governance rights.96 This decision treats litigation rights as first-class rights.
D. The Availability Of Injunctive Relief
The defendants finally argue that even if the plaintiffs have stated a claim on which relief can be granted, they cannot obtain an injunction blocking the Company and Holdings from leaving Delaware. They seem to think that as a matter of policy, a Delaware court cannot enjoin an entity from leaving the state. That assertion goes too far. In extreme scenarios, courts have the power to prevent persons and assets from leaving their jurisdiction when doing so is necessary to preserve their ability to award final relief.97 In theory,
Before addressing the availability of an injunction, a cautionary note is in order about pleading-stage efforts to rule out remedies. A
The plaintiffs have asked the court to enjoin the conversions. To obtain a permanent injunction, the plaintiffs will have to prevail on the merits and prove that “other remedies are inadequate.”100 To meet that test, a plaintiff need not show irreparable harm. “A showing of irreparable harm can satisfy that requirement. But establishing irreparable harm is not strictly necessary.”101 Conversely, if legal remedies are adequate, then a plaintiff cannot make the showing necessary for injunctive relief.102
The standard legal remedy is money damages. It seems quite likely that the court can craft a monetary remedy in this case that would be adequate. The remedial challenge will be to quantify the extent of the harm, if any, that moving from Delaware to Nevada imposes on the unaffiliated stockholders.
One way to determine the quantum of harm would be to value the Company pre-conversion as a Delaware corporation, then value the Company post-conversion as Nevada corporation, subtract the Nevada value from the Delaware value, and calculate a per share amount. That would be hard.
But there is another way to get at the delta. The Company‘s stock has a trading price. In the conversion, nothing will change except the Company‘s corporate
Given that set-up, the change in the Company‘s trading price should help quantify the harm, if any, caused by the conversion. As long as the market for the Company‘s common stock is semi-strong-form efficient, then the price reaction should be indicative. Note that the stock price need not fairly approximate a pro rata share of the Company‘s intrinsic value for the price reaction to matter. As long as any pricing disconnects remains consistent across variables other than the governing law, the price impact should provide insight.
Not only that, but the announcement of the conversion should have a relatively clean price impact. The Company‘s conversion was not conditioned on a majority-of-the-minority vote, so nothing could prevent Holdings from implementing it. There is, of course, always some uncertainty about whether a transaction will close, but here, the likelihood of closure would have been high. The price reactions to other events, such as the announcement of the vote or the filing of this litigation, may provide additional datapoints.
That does not make the price reaction the be all and end all. Considerable scholarly literature calls into question the ability of investors to price governance structures at the IPO phase.103 Similar uncertainty could exist about the ability of investors to price changes in governance structures. Intuitively, however, a change in governance structure should present a cleaner question. At the IPO stage, a firm‘s economic prospects dominate, and the way a stockholder controller, the board, or management may use the governance rights they possess is relatively unknown. For the conversion, the only question is a change in the governing law, and the Company‘s fiduciaries have a track record.
Because of the narrow issue that this case presents, it seems likely that the court will have a sufficiently reliable basis to craft a monetary award for any harm that the Company‘s stockholders suffer. A judgment against the defendants in that amount should provide the plaintiff with a fully adequate remedy. The court will retain jurisdiction over the individual defendants even after the conversion is complete. The court can enter a judgment against any of them who are held liable. The plaintiffs can use standard collection procedures to enforce the judgment. If that requires domesticating judgments in other jurisdictions and enforcing them there, then the plaintiffs can do that.
The closing of the conversion will not alter anything else about the case. By statute,
[t]he conversion of a corporation out of the State of Delaware in accordance with this section and the resulting cessation of its existence as a corporation of this State pursuant to a certificate of conversion to non-Delaware entity shall not be deemed to affect the personal liability of any person incurred prior to such conversion, nor shall it be deemed to affect the choice of law applicable to
the corporation with respect to matters arising prior to such conversion.104
Any liability for the conversion necessarily arises prior to the mystical singularity of the effective time. This case will go forward, governed by Delaware law, regardless of whether the Company‘s conversion closes. The same is true for the conversion involving Holdings.
Injunctive relief is therefore off the table. The pendency of this litigation should not delay the conversions from closing.
III. CONCLUSION
The defendants’ motion to dismiss is granted as to the plaintiffs’ request for injunctive relief. Otherwise, the motion is denied.
Notes
The norm of equal treatment resonates deeply in American culture, but we should not ignore the fact that nominally equal treatment can have disproportionate effects. That generally will not be the case when recipients are similarly situated. It often will be the case when recipients are differently situated. In a controlled company, the stockholder controller and the unaffiliated stockholders are differently situated. Nominally equal treatment in a controlled company can therefore lead to disproportionate and inequitable results.