In the case of TripAdvisor Inc., the Delaware Court of Chancery held that the corporation’s decision to reincorporate in Nevada is subject to the entire fairness standard. The court found that, based on the facts pled, converting to Nevada was a self-interested transaction that conferred a non-ratable benefit upon the controlling stockholder. The court’s decision provides useful guidance for corporations considering changing their state of incorporation from Delaware without triggering entire fairness.
There has been much talk recently about corporations leaving Delaware for the supposedly greener, more fiduciary-protective pastures of states such as Nevada. One such company, TripAdvisor, decided to take the plunge and convert from a Delaware to a Nevada corporation. A stockholder challenging the conversion sued the board and controlling shareholder, and the defendants moved to dismiss. Vice Chancellor J. Travis Laster denied the motion to dismiss.
Overview of Decision
The court noted that its decision was based on the specific set of facts pled by the plaintiffs. The CEO/chair was the controlling stockholder, holding 56% voting control. The complaint cited board materials allegedly showing that the board decided to convert to a Nevada corporation because Nevada law offered more litigation protections for directors and officers and fewer litigation rights for stockholders, including a narrower application of entire fairness to controller transactions; no individual fiduciary liability except for intentional misconduct, fraud, and knowing violation of the law; and no Revlon duties.
The court emphasized that it was not “finding that Nevada provides greater protection against fiduciary liability than Delaware law,” only that, based on the allegations in the complaint, “it is reasonably conceivable that Nevada law offers greater protection.” Critical to the court’s analysis, prior to the conversion, the board did not put in place the twin protections under Kahn v. M&F Worldwide Corp. (MFW) or any other protections to simulate arm’s-length bargaining. Once the board recommended the conversion, the controller delivered the majority stockholder vote to approve the conversion as required by DGCL § 266.
The court held that the plaintiffs stated a claim on the facts alleged because (1) there was a controller, (2) the board did not implement any protective provisions with respect to the controller’s self-interest, and (3) the board or controller did not compensate the unaffiliated stockholders for the reduction in their litigation rights. The court noted “[c]hange any of those variables and the outcome could be different.” The court did not, however, enjoin TripAdvisor from converting to Nevada, stating that a monetary remedy could be fashioned posttrial.
Conversion from Delaware to Nevada Conferred a Non-Ratable Benefit
The defendants conceded the existence of a controller and the absence of MFW protections, so the key issue was with the existence of a non-ratable benefit. The court found that the complaint adequately alleged that converting to Nevada law was a material non-ratable benefit to the controller because the “litigation rights” afforded to stockholders by Nevada law were less valuable than the stockholders’ litigation rights under Delaware law, which reduced the fiduciaries’ “future-potential liability” and litigation risk.
The benefit exists even if there was no “existing potential liability” (a pending lawsuit or the conduct giving rise to a lawsuit already happened). The court likened the benefit to the controller here to an insurance policy: Obtaining coverage for future potential liabilities that have not yet happened is a benefit that insureds pay premiums to get. The court found that a stockholder’s right to sue is part of what they pay for when buying shares in a Delaware corporation, and it has value even if no misconduct occurred at the time.
Application of Entire Fairness Where There Is No ‘Price’
The court addressed the practicality of applying the entire fairness standard to this situation where there is no monetary “price” to assess. The court explained that entire fairness is a unitary test with substantive and procedural aspects. The substantive component is fulfilled when the stockholders receive the “substantial equivalent of what they had before.”
The procedural component analyzes the process of how the transaction was structured, negotiated, and approved. Here, substantively, the stockholders were left with less than they had before. Before the conversion, the unaffiliated stockholders had a bundle of litigation rights under Delaware law—after the conversion, those stockholders will only have litigation rights under Nevada law, which are less than the rights under Delaware law. Procedurally, no protections were put in place to simulate arm’s-length bargaining.
The CEO/controller proposed conversion to Nevada, the board (on which the controller sat) recommended it, and the controller approved it as majority stockholder. The court held that the fact that the unaffiliated stockholders overwhelmingly voted against the conversion supports an inference of unfairness. The court noted that this decision does not discriminate against Nevada entities because the same reasoning would apply if a Delaware corporation converted to another Delaware entity with comparable limitations, such as a Delaware LLC without fiduciary duties or with lesser unitholder litigation rights.
What Delaware Corporations Considering Conversion Should Know
The key takeaway for boards of Delaware corporations thinking of reincorporating in a supposedly less restrictive, more protective jurisdiction such as Nevada is that Delaware courts will carefully scrutinize any conversion, highlighting the importance of working closely with counsel to structure the transaction to avoid triggering entire fairness review.
Those Without a Controller
If the corporation does not have a controlling stockholder, the board should fully disclose all consequences of the change in legal regimes under Nevada law (or any other state of reincorporation), including the effect on stockholder litigation rights and the reduction in directors’ and officers’ liability risk, and obtain majority stockholder approval to trigger the irrebuttable presumption of the business judgement rule under Corwin.
Those With a Controller
If the corporation has a controlling stockholder, the board should assess whether it is possible to put in place the twin MFW protections to get business judgment rule deference, conditioning the conversion on approval of an independent, fully functioning special committee of independent directors and a majority of the unaffiliated stockholders.[1] It is also helpful if the board fairly compensates stockholders for giving up litigation rights in the conversion.
[1] Depending on the outcome of the Match Group Inc. litigation currently pending before the Delaware Supreme Court, boards may only need approval by one of three “cleansing mechanisms” to invoke the business judgment rule: (1) approval by a majority of independent directors, (2) approval by a special committee of independent directors, or (3) approval by a majority of disinterested stockholders.
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