IN RE DELL TECHNOLOGIES INC. CLASS V STOCKHOLDERS LITIGATION
There has been a growing deference in Delaware courts for transactions approved by independent special committees and minority stockholders. In the context of a company with a controlling stockholder, the Delaware Supreme Court has provided guidance in Kahn v. M&F Worldwide Corp.[1] (“MFW”) on how boards can structure special committees and minority stockholder votes to have board decisions adjudicated under the highly deferential protection of the business judgment rule.[2] However, the Delaware Court of Chancery recently found in In re Dell Technologies Inc. Class V Stockholders Litigation[3] (“Dell”) that it was reasonably conceivable that the conditions established in MFW had not been satisfied in the transaction under review resulting in the application of the more onerous entire fairness standard of review.[4] The opinion in Dell provides helpful insight for boards as they navigate transactions involving controlling stockholders.[5]
Under the framework established in MFW, a controlling stockholder transaction can receive the business judgment rule standard of review if the transaction is approved by (i) a fully empowered special committee comprised of independent and disinterested directors that satisfy their duty of care, and (ii) a fully-informed and uncoerced vote of a majority of the minority stockholders that are not affiliated with the controller.[6] As shown in Dell, the court will review the facts and circumstances surrounding the transaction to determine whether these prongs have been satisfied. Accordingly, when faced with controlling stockholder transactions, boards will need to proactively and carefully assess the way that they constitute their special committees and how they interact with minority stockholders.
Background
The transaction in Dell first traces back to when Dell, Inc. (the “Company”) sought to acquire EMC Corporation, which had an 81.9% stake in VMware, Inc. As an alternative to customary cash and stock transaction structures, the Company structured the transaction to include, as a part of the consideration, the issuance of shares of a newly created Class V share, which shares were designed to track the performance of VMware. One feature of the Class V shares was that they were subject to a mandatory conversion right that permitted the Company to convert the shares into Class C shares of the Company. The Company’s mandatory conversion right contributed to the shares trading at a 30% discount relative to the value of VMware.
The Company desired to consolidate its ownership of VMware and explored a potential redemption of the Class V Shares. The Company’s board of directors established a special committee to negotiate the redemption and conditioned the redemption of the shares on the approval by the special committee and the holders of a majority of the outstanding Class V shares. However, the Company retained the right to exercise the mandatory conversion. This raised a factual issue about the special committee’s ability to fully negotiate with the stockholders and whether the committee and stockholders were in a coercive situation. Also, when negotiations stalled, the Company negotiated directly with a group of the minority stockholders. The court ruled that the Company failed to comply with the requirements of MFW, which resulted in the transaction being subject to the entire fairness standard of review.
Key Takeaways
The opinion in Dell provides some direction for boards that desire to afford themselves the protections of the business judgment rule in connection with controlling stockholder transactions. The analysis is complex and fact specific and so boards should work closely with counsel from the outset of the process in order to formulate a plan.
- Boards must first determine whether the transaction involves a controlling stockholder. The protections from MFW only apply in the context of a controlling stockholder transaction. In situations where there is no controlling stockholder, the court will review the transaction under the line of cases following from Corwin v. KKR Financial Holdings LLC.[7] If MFW is applicable, Boards will need to convene a special committee that is fully empowered (including the definitive right to say no to the transaction) and comprised of independent and disinterested directors that are acting in accordance with their duty of care and condition the transaction on the approval by the special committee and a majority of the minority stockholders that are not affiliated with the controller.
- Boards must ensure that the transaction is conditioned on approval from the special committee and minority stockholders ab initio. MFW established that boards must condition the transaction on approval by the special committee and minority stockholders from the beginning through the end of the transaction. Although not at issue in Dell, the Delaware Supreme Court previously clarified in Flood v. Synutra Int’l Inc.[8] that the board must establish these conditions before substantive negotiations on the economic terms begin.
- Boards must ensure that the controlling stockholder irrevocably relinquishes its ability to exert its control in connection with the negotiation process. When a controlling stockholder exerts or threatens to exert its control, it may raise a factual issue as to whether it had a coercive effect on the special committee or the minority stockholders, the negotiations or voting on the merits of the transaction. Boards need to ensure that the controlling stockholder “irrevocably and publicly disables” its ability to use its control in connection with the negotiation and approval process. By retaining the right to exercise the mandatory conversion, it conceivably created a coercive situation for the special committee and stockholders.
- Boards must fully empower the special committee with the definitive right to say no to the transaction. The scope of authority granted to the special committee by the board specifically excluded the power to exercise the mandatory conversion right. By retaining a backup plan, the board failed to give the special committee sufficient autonomy and authority. This was similarly at issue in Kahn v. Lynch Communication Systems, Inc.,[9] where the special committee’s ability to negotiate was conceivably impeded by the threat of a hostile tender offer by the controlling stockholder. While boards do not need to protect against every hypothetical transaction, boards should disable their ability to proceed with any transaction that is similar to the proposed transaction and should confer power on the special committee to have definitive authority over whether or not to proceed with the transaction.
- Boards should not directly participate in the negotiation of the transaction. In Dell, negotiations between the Class V stockholders and the special committee stalled and certain of the minority stockholders began to negotiate directly with the Company in lieu of the special committee, and ultimately negotiated a better deal than the special committee. However, the conditions under MFW contemplate that the special committee will act as the negotiating agent for the minority stockholders and the minority stockholders, in a complementary role, will have the right to approve or reject the transaction negotiated by the special committee. The stockholders cannot replace the role of the special committee. Stockholders do not have access to non-public information of the company and they do not owe a fiduciary duty to the other stockholders and so are not in the best position to serve as the negotiating agent. If negotiations stall, the special committee should reengage and continue to act in its fiduciary capacity in order for the board to avail itself of the business judgment rule under MFW.
- Boards and controlling stockholders need to ensure that the special committee and the minority stockholders are not placed in a coercive situation. The threat of the mandatory conversion conceivably had a coercive effect that caused the stockholders to make a decision for reasons other than the merits of the transaction and potentially undermined the ability of the special committee to bargain effectively. Boards need to be mindful of putting the minority stockholders and special committee in the position of having to choose between the transaction and a worse alternative. Moreover, even though the mandatory conversion right was conferred in the Company’s certificate of incorporation, this was not enough to prevent the right from having a coercive effect under the circumstances.
- Boards must ensure that special committees are comprised of disinterested and independent directors. The court identified certain longstanding business and social ties of the committee members with the controlling stockholders. To satisfy the requirements of MFW, independence must be established at the pleading stage, where plaintiffs have a less stringent burden to establish a “reasonable inference” that a member of the special committee was not disinterested and independent.
- Boards must ensure that they disclose all material information to the stockholders and that the disclosures are not otherwise materially misleading.[10] Information is material “if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”[11] In Dell, the complaint identified three categories of material information that were not disclosed or were arguably presented in a materially misleading way, including:
- the failure to disclose a proposal by the special committee for a negotiated redemption at a specified share price,
- inadequate disclosure regarding the compensation and potential conflicts and inadequacy of the investment banker, and
- the failure to disclose that the special committee members were aware of a valuation by Deloitte relating to the Class C shares into which the Class V shares could be converted.
The Dell case is a reminder of the highly complex and fact specific nature of corporate transactions. Boards should engage experienced counsel from the outset to help form a plan and to proactively navigate any issues that may arise.
FOOTNOTES
[1] Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).
[2] The business judgment rule protects a director of a corporation from liability for business decisions made in good faith if the director is informed to the extent he or she reasonably believes to be appropriate under the circumstances and reasonably believes that the decision is in the best interests of the corporation. See e.g., Grobow v. Perot, 539 A.2d 180 (Del. 1988). The business judgment rule places the initial burden of proof on the plaintiff in challenging a director’s decision.
[3] In re Dell Tech. Inc. Class V. S’holders Litig., 2020 WL 3096748 (Del. Ch. Jun. 11, 2020).
[4] If the plaintiff proves that the directors involved in the business decision breached any of their fiduciary duties or lacked independence in the process, then the presumption under the business judgment rule is overcome and the court will apply the entire fairness doctrine. Under the entire fairness standard of review, the burden shifts to the directors to prove that the decision process and price were fair to the stockholders of the corporation. See e.g., Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983).
[5] Controlling stockholders include those who own a majority interest in the corporation and de facto controlling shareholders. De facto controlling shareholders are those who control the company although they have less than 50% of the vote. See e.g., In re Zhongpin Inc. S’holders Litig., C.A. No . 7393-VCN, 2014 WL 6735457, at *7–*9 (Del. Ch. Nov. 26, 2014) (17.3% stockholder deemed controlling under Delaware law at pleading stage where the stockholder was alleged to be the company’s largest stockholder, founder, chairman, and CEO. Plaintiffs also argued that the stockholder exercised meaningful influence over the company’s business decisions, including director elections and merger transactions.).
[6] See MFW, 88 A.3d at 645.
[7] Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015).
[8] Flood v. Synutra Int’l, Inc., 195 A.3d 754 (Del. 2018).
[9] Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110 (Del. 1994).
[10] Morrison v. Berry, 191 A.3d 268, 282 (Del. 2018).
[11] Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985).