In Palkon v. Maffei, C.A. No. 2023-0449-JTL, 2024 Del. Ch. LEXIS 48 (Del. Ch. Feb. 20, 2024) (Laster, V.C.) the Delaware Court of Chancery considered whether a controlling stockholder’s approval of transactions reincorporating two Delaware corporations in Nevada is subject to entire fairness review where there was a lack of procedural protections that would give the approval of the transactions the patina of arms-length bargaining. Because the stockholders’ derivative complaint contained allegations that (if true) established that the disputed transactions adversely affected investor protections, the Court of Chancery applied the inherently-factual “entire fairness” standard of review and denied the defendants’ motion to dismiss.
TripAdvisor, Inc. and its controlling stockholder Liberty TripAdvisor Holdings, Inc. (“Holdings” collectively, the “Companies”) decided to convert from Delaware corporations to Nevada corporations. In making this decision, the Companies cited what it believed were greater protections against liability for directors and officers under Nevada law as one of the primary reasons for the conversions. The boards of both Companies approved the conversions without implementing any procedural protections in favor of the minority stockholders. The controlling stockholder of the Companies and CEO and Chairman of Holdings (the “Controlling Stockholder”) exercised his control to unilaterally approve the Companies’ reincorporation in Nevada.
Two stockholders (one for each of the Companies) challenged the conversions, arguing they were self-interest transactions that were not entirely fair to minority stockholders because the conversions gave the Controlling Stockholder and other insiders a non-ratable benefit by allegedly reducing defendants’ exposure to liability. Plaintiffs sought damages and to enjoin the conversions. Defendants moved to dismiss for failure to state a claim and argued that the decision to reincorporate in Nevada should be governed by the more deferential business judgment rule and not the entire fairness standard of review. The Court granted the portion defendants’ motion seeking the dismissal of the claim for injunctive relief, but denied the remainder of the motion.
As threshold matter, the Court agreed with plaintiffs, finding that the “entire fairness” standard governs where, as in Maffei: (i) the board failed to implement procedural protections for the minority stockholders, (ii) the transaction is between a corporation and its controlling stockholder and (iii) the controlling stockholder receives a non-ratable benefit.
The Controlling Stockholder’s status as a controller and the board’s failure to implement procedural protections were undisputed. For this reason, the Court focused on the second criterion—i.e., whether defendants received a non-ratable benefit from the transaction. The Court found that they did: “A controller or other fiduciary obtains a non-ratable benefit when a transaction materially reduces or eliminates the fiduciary’s risk of liability.”
Defendants next argued that the entire fairness standard did not apply because the reconversion was not a monetary transaction. The Court rejected this argument by pointing to the myriad of cases in Delaware that apply the entire fairness standard of review to non-monetary transactions. The concept of entire fairness extends beyond mere pricing to ensure that, after the disputed transaction, the minority stockholders receive the substantive equivalent in value of their holdings that existed before the transaction.
Before the conversion, “the unaffiliated stockholders enjoyed all of the litigation rights provided by Delaware law,” but after the conversion would “possess only the litigation rights provided by Nevada law.” Given the allegations in the complaint, the Court deemed that the stockholders’ litigation rights under Nevada law were “inferably less than what Delaware provides.” Moreover, “defendants did not make any effort to replicate arm’s length bargaining.” Rather, “Management proposed the conversions, the Board recommended them, and Holdings and Maffei approved them.” Accordingly, plaintiffs stated a claim for relief under the entire fairness standard of review. The Court, nevertheless, declined to enjoin the closing of the conversions because money damages could adequately compensate the minority stockholders for the loss in value attributable to the alleged loss of stockholder protections.
The Palkon decision is in harmony with extensive Delaware jurisprudence applying the entire fairness standard to alleged self-interested company transactions favoring a controlling stockholder. To the extent Delaware corporations anticipate engaging in transactions involving controlling stockholders that may alter stockholder rights, best practices would include implementing procedural fairness mechanisms such as: (i) the full disclosure to the stockholders of the potential conflict; and (ii) the approval of the transaction by both an independent special committee of the board and the majority of the minority stockholders. Applying these prophylactic measures lessens the risk that, in litigation, a Court would employ the entire fairness standard to review the disputed corporate decisions.