Defense Delaware Litigation / Trial Practice Securities & SEC

Overpayment Claims Still Valid in Absence of Controlling Shareholder

Overpayment Claims Still Valid in Absence of Controlling Shareholder

On July 26, 2018, Vice Chancellor Glasscock of the Delaware Courtroom of Chancery denied in half and granted in half Defendants’ movement to dismiss in Sciabacucchi v. Constitution Communications Company et al.  We mentioned the Courtroom’s prior ruling in this motion right here.  In short, the motion challenged sure transactions between Constitution Communications, Inc. and its largest stockholder, Liberty Broadband Company, which owned roughly 26% of Constitution’s excellent widespread inventory and had the correct to designate 4 of ten administrators on Constitution’s Board.  Particularly, a Constitution stockholder challenged a voting proxy settlement between Constitution and Liberty and two inventory issuances value $5 billion made by Constitution to Liberty, allegedly as an element of the “financing” of Constitution’s $78.7 billion merger with Time Warner Cable and its buy of Shiny Home Networks, LLC.  Finally, 86% of Constitution inventory not affiliated with Liberty voted, in a single vote, to approve (i) the share issuances and the voting settlement, (ii) the merger with Time Warner Cable and (iii) the acquisition of Vibrant Home.  Each third-party transactions have been conditioned on Constitution stockholders’ approval of the share issuances to and voting settlement with Constitution.

In accordance with Plaintiff, the defendant administrators breached their fiduciary duties in approving the Liberty-Constitution transactions as a result of: (i) Liberty was paying $173/share for the $700 million in newly issued Constitution inventory, which represented a reduction to Constitution’s market worth on the time; (ii) Constitution’s $four.three billion issuance of inventory to Liberty in reference to the Time Warner Merger was unfair as a result of that worth purportedly did not take account of the undertaking worth of the mixed corporations following the merger; (iii) Constitution’s determination to permit solely Liberty to obtain all inventory for its Time Warner shares (whereas different Time Warner shareholder acquired a mixture of money and inventory) was unfair as a result of it gave Liberty a tax profit not out there to all different stockholders; and (iv) the grant of a 6% voting proxy to Liberty by Advance/Newhouse Partnership, the then-owner of Brilliant Home), such that Liberty’s voting energy post-closing of the Brilliant Home transactions can be no less than 25.01% (thereby permitting Liberty to “escape regulation” beneath the Funding Firm Act of 1940), unfairly transferred voting energy from public stockholders to Liberty by allowing Liberty to take care of its pre-transaction voting energy however that post-transaction it solely owned roughly 20% of the mixed entities. 

Defendants moved to dismiss on the bottom that the stockholder votes approving the transaction had a “cleansing effect” underneath Corwin v. KKR Monetary Holdings LLC, thereby subjecting the transaction to deferential enterprise judgment evaluate.  Beneath Corwin, a totally knowledgeable, uncoerced vote of the bulk of disinterested inventory outcomes in enterprise judgment assessment attaching to the transaction so authorised, resulting in dismissal absent an sufficient pleading of waste.  The Courtroom held that the vote was structurally coercive as a result of stockholders have been left with “a simple choice: accept (disloyal) equity issuances to the Company’s largest stockholder, and an agreement granting that stockholder greater voting power, or lose two beneficial transactions.”

Regardless of figuring out that Corwin subsequently didn’t apply in order to offer cleaning impact to the stockholder vote, the Courtroom held that the briefing was inadequate for a willpower on the remaining grounds in Defendant’s movement to dismiss and ordered further briefing on the movement.  In its most up-to-date determination following supplemental briefing, the Courtroom discovered that the Plaintiff’s claims have been by-product in nature, and subsequently dismissed the direct claims.  However as to the by-product claims, the Courtroom discovered that the grievance adequately pled that demand on the Constitution board was excused, and that complete equity fairly than deferential enterprise judgment rule evaluation utilized, as a result of a majority of the Constitution administrators who accepted the challenged Constitution-Liberty transactions have been beholden to John Malone, a Constitution director who was in the transactions by advantage of his possession of 47% of the voting energy of Liberty.  Consequently, the by-product claims survived.

Key Takeaways and Evaluation

Company Overpayment Claims Can’t Be Each Direct and By-product in the Absence of a Controlling Stockholder

Plaintiff’s grievance asserted each by-product and particular person claims referring to “corporate overpayment” – i.e., Constitution overpaid Liberty by “issuing it stock for allegedly unfair consideration” and receiving “inadequate consideration from Liberty in exchange for agreeing to grant it the 6% voting proxy.”  Defendants argued that these claims have been by-product solely and sought dismissal of the direct claims.  The Courtroom agreed.

Beneath the rule introduced in Gentile v. Rossette,1 the Delaware Supreme Courtroom held that a company overpayment declare could also be each direct and by-product the place (1) a controlling stockholder causes an organization to situation extreme shares of its inventory in trade for belongings of the controlling stockholder which have a lesser worth and (2) the change causes a dilution of the voting rights of public stockholders and a lower in these shares’ financial worth.  The Supreme Courtroom revisited the difficulty in El Paso Pipeline GP Co., LLC v. Brinckerhoff,2 the place it rejected the Plaintiff’s declare that a direct and by-product declare existed the place a company overpayment resulted in the extraction of strictly financial worth.  As an alternative, the El Paso Courtroom held that absent any proof of dilution of Plaintiff’s voting rights plus the extraction of financial worth, the declare is by-product solely.

Vice Chancellor Glasscock noticed that two Courtroom of Chancery selections since El Pasohave held that a controlling stockholder should exist previous to the challenged transaction.  In Carr v. New Enterprise Associates, Inc., Chancellor Bouchard wrote, “the Gentile paradigm only applies when a stockholder already possessing majority or effective control causes the corporation to issue more shares to it for inadequate consideration.”three  Relying upon his earlier opinion in this motion holding that Malone and Liberty Broadband weren’t controlling stockholders, the Courtroom discovered that Plaintiff couldn’t assert a twin direct and by-product declare in the present case beneath Gentile and El Paso.  Notably, Vice Chancellor Glasscock lamented that relying upon El Paso and never making use of Gentile to “conflicted board non-controller dilution cases . . . is, as matter of doctrine, unsatisfying.”

Materials Outdoors Enterprise Relationships, Public Feedback on an Director’s Affect, and an Social gathering’s Sway Over a Director’s Full-Time Employment Proceed to Be Indicia of a Lack of Independence on the Pleading Stage

The Courtroom discovered that the Grievance had adequately raised an inexpensive doubt that at the least half the ten-person Constitution board might pretty think about a requirement resulting from their ties to an director, John Malone, thereby excusing demand.  Defendants conceded the shortage of independence of two of the 4 Liberty-designated administrators, Malone and Gregory Maffei.  As to the opposite three administrators the Courtroom analyzed and located to lack independence:

  • Balan Nair, one other Liberty designee, served as Government Vice President and Chief Know-how Officer of Liberty International plc, in which Malone held a 25% stake and was Chairman of the Board of Administrators. In response to the Courtroom, absent some “unusual fact” akin to “inherited wealth,” when “a director is employed by or receives compensation from other entities, and where the interested party who would be adversely affected by pursuing litigation controls or has substantial influence over those entities, a reasonable doubt exists about the director’s ability to impartially consider a litigation demand.”  Right here, Malone’s possession curiosity in Liberty mixed together with his position as Board Chairman put him “in a position to exercise considerable influence over Nair.”

  • Thomas Rutledge had served as Constitution’s CEO and as a board member since 2012. Not solely was Rutledge a full-time Constitution worker in a state of affairs the place Liberty (in which Malone owned a 47% stake) managed 26% of Constitution’s inventory, however in public feedback Rutledge conceded Malone’s affect.  In an interview with the New York Occasions, Rutledge “did not deny Malone’s influence, stating ‘[w]hen he talks, I listen.  And he is a significant talker.”  

  • Eric Zinterhofer had been Chairman of the Constitution Board since 2009 and a founder of Searchlight Capital Companions, LLC, a personal fairness agency that in 2012 acquired a Puerto Rican cable firm in a three way partnership with Liberty International. Two years later, Liberty International and Searchlight introduced a three way partnership to buy one other Puerto Rican cable firm – the mixed entity is the most important cable firm in Puerto Rico.  Subsequently, because the grievance alleged, “Zinterhofer is a current business partner with Liberty Global and Malone in corporate enterprises worth almost $1 billion.”  The Courtroom discovered that, on the pleading stage, “it is reasonable to infer that joint ventures of this size are important to their principals, even if those principals have high net worth,” and that the joint ventures are “material to the firms involved, even absent details regarding the size of those firms’ investment portfolios.”  Whereas the Courtroom acknowledged that allegations of a “mere outside business relationship, standing alone,” are inadequate to undermine a presumption of independence, a “pleading-stage inference of beholdenness may arise” the place, as in this case, there are allegations that a director’s enterprise relationship with an celebration is materials to the director.

Delaware Courts Stay Open to Contemplating Public Statements Made by a Director Relating to an Social gathering’s Affect

As famous above, the Courtroom thought-about statements by Rutledge to the New York Occasions in concluding that Plaintiffs had raised an inexpensive inference that he was beholden to Malone.  The Courtroom’s consideration of such statements isn’t an remoted occasion.  As an example, in In re Tesla Motors, Inc. Stockholder Litigation, determined earlier this yr, the Courtroom of Chancery relied on prior public statements by Tesla and Elon Musk, Tesla’s Chairman, CEO and proprietor of 22.1% of its excellent inventory, in contemplating Mr. Musk’s standing as a controlling stockholder.  Tesla’s SEC filings, for instance, included numerous statements relating to Mr. Musk’s significance to the Firm, together with disclosure relating to Mr. Musk’s position in “recruiting executives and engineers, contributing to the Tesla Roadster’s engineering and design, raising capital for us and bringing investors to us, and raising public awareness of the Company,” in addition to a danger issue offering that “[Tesla is] highly dependent on the services of Elon Musk, [who is] highly active in [the Company’s] management, [and if Tesla were to lose his services, it could] disrupt our operations, delay the development and introduction of our vehicles and services, and negatively impact our business, prospects and operating results as well as cause our stock price to decline.”  Furthermore, Mr. Musk typically referred to Tesla as “my company,” revealed two “Master Plans” in which he described his strategic path for Tesla, and beforehand said that had he not develop into CEO of Tesla “the company wasn’t going to make it.”

The Independence of the Full Ten-Individual Constitution Board Decided Whether or not the Enterprise Judgment Rule Utilized Even Although Solely the Six Non-Liberty Designees Voted on the Challenged Constitution-Liberty Transactions

As a result of the Courtroom discovered that at the least half the Constitution Board lacked independence, not solely was demand excused but in addition the enterprise judgment rule wouldn’t apply, and the transactions can be assessed beneath the complete equity commonplace.  Defendants argued, nevertheless, that solely the six non-Liberty designees permitted the challenged transactions and a majority of these administrators have been unbiased, such that enterprise judgment rule evaluation was warranted.  The Courtroom disagreed.  It discovered that the 4 Liberty designees, together with the remaining of the board, “approved the acquisitions of Time Warner and Bright House, and the structure whereby those deals would not close unless the challenged transactions received stockholder approval.  Thus, by signing off on the structurally coercive terms of the acquisitions, the Liberty designees helped ‘strong arm[]’ the stockholders into voting for the [challenged] transaction[s] ‘for reasons outside of the economic merit’ of the decision.”  Accordingly, to rebut the enterprise judgment rule, Plaintiff was required to name into query the independence of at the least 5 members of the ten-person board, not 4 of the six non-Liberty designees.


1   906 A.second 91 (Del. 2006).

2   152 A.3d 1248 (Del. 2016).

three   2018 WL 3388398 (Del. July 11, 2018) (emphasis added)