• Delaware Court of Chancery holds decision to reincorporate from Delaware to Nevada provided a non-ratable benefit to a controlling stockholder and directors due to potential reduction in future legal liability.
• Due to that non-ratable benefit, the Court of Chancery applied entire fairness review and denied Defendants’ motion to dismiss.
• Delaware Supreme Court granted an immediate appeal of the Court of Chancery’s order.

The Delaware Court of Chancery issued an order in Palkon v. Maffei¹ on February 20, 2024, holding that a decision by the boards of directors and the controller of TripAdvisor, Inc. (“TripAdvisor”) and Liberty TripAdvisor Holdings, Inc. (“Liberty”) to convert each entity from a Delaware corporation to a Nevada corporation was subject to review under entire fairness. Vice Chancellor Laster explained that the Nevada conversions amounted to an interested transaction whereby the directors and the controller would receive a non-ratable benefit—i.e., a potential reduction of future legal liability due to Nevada being potentially more protective of fiduciary defendants than Delaware. The Court of Chancery further hypothesized potential damages calculations in lieu of enjoining the conversions.²

After the Court of Chancery denied their motion to dismiss, Defendants applied for an interlocutory appeal to the Delaware Supreme Court. Recognizing the novel question of law raised by the Court of Chancery’s decision, the benefits of a timely consideration of the issues raised by the trial court, and the potentially case dispositive nature of an appeal, on April 16, 2024, the Delaware Supreme Court granted interlocutory review.

Background³

TripAdvisor has two classes of stock.⁴ One class has one vote per share and trades publicly.⁵ The other class has ten votes per share and is owned by Liberty.⁶ Liberty also has its own dual-class structure, with Liberty’s CEO controlling 43% of Liberty’s voting power.⁷ For purposes of the motion to dismiss, Defendants conceded that Liberty’s CEO controlled both TripAdvisor and Liberty.⁸

In 2022, the boards of TripAdvisor and Liberty, each a Delaware corporation, decided to convert each company to a Nevada corporation.⁹ Assuming that Liberty’s CEO cast all of his and Liberty’s votes in favor of the conversions, each passed with less than a majority of the unaffiliated stockholders of TripAdvisor and Liberty voting in favor.¹⁰ Neither conversion was conditioned on approval by a special committee of the board of directors of the respective company or by a majority-of-the-minority stockholders.¹¹

TripAdvisor and Liberty stockholders sued, arguing that Liberty’s CEO and the directors of each company breached their fiduciary duties in approving the conversions because Nevada law offered “fewer litigation rights to stockholders” and “greater litigation protections to fiduciaries like the directors and the CEO/Chair.”¹² The stockholders sought an injunction preventing each company from reincorporating in Nevada. In its decision on Defendants’ motions to dismiss, the Court of Chancery held that Plaintiffs stated a claim, which would be reviewed under entire fairness, but that the Court would not enjoin the reincorporations.

The Court of Chancery’s Decision

The Court of Chancery Applies Entire Fairness

The Court of Chancey began by examining which standard of review—business judgment rule or entire fairness—should apply to Plaintiffs’ claims. The Court found that entire fairness review, “Delaware’s most onerous standard,” was appropriate.¹³

Vice Chancellor Laster explained that, at the pleading stage, the Court could reasonably infer that Nevada law provided greater protections for fiduciaries than Delaware law, and that the conversion would confer a material benefit on Defendants by reducing their litigation exposure.¹⁴ In particular, the Court focused on the alleged reduction in the bundle of litigation rights that Delaware law provides but Nevada law allegedly does not.¹⁵ Moreover, the Court concluded that Plaintiffs sufficiently called into question the procedural fairness of the conversions because there was no effort by Defendants to replicate arms’ length bargaining in proposing, recommending, and approving the conversions.¹⁶

The Court analogized the conversion’s liability-limiting effect to the many Delaware cases where a merger extinguished derivative claims, thereby conferring a non-ratable benefit on the corporation’s fiduciaries.¹⁷ Defendants argued that each of those cases involved legal claims that already existed, whereas no claims were pending against Defendants when they approved the conversions. Vice Chancellor Laster responded that “the defendants’ arbitrary distinction between existing potential liability and future potential liability would make Delaware law piteously naive,” and cited insurance policies and options contracts as examples where “litigation risk can exist even though the specific events have not happened yet.”¹⁸ Thus, despite the transaction at issue not involving a merger that extinguished pending claims, and being merely a conversion pursuant to Section 266 of the Delaware General Corporation Law approved on a clear day, the Court wrote “[t]here is no reason why similar principles of law would not apply to a conversion.”

In applying entire fairness, the Court dismissed Defendants’ arguments that entire fairness was infeasible in a Delaware-to-Nevada conversion because no transaction had occurred.¹⁹ The Court reasoned that it could conduct an entire fairness review of the conversions under the “substantive dimension” of entire fairness, to determine “whether stockholders received the substantial equivalent of what they had before.”²⁰

Accordingly, the Court of Chancery determined that Plaintiffs sufficiently pled the conversions were self-interested transactions subject to entire fairness review.

The Court of Chancery Rejects an Injunction, Holding Damages Are an Adequate Remedy

The Court of Chancery agreed with Defendants that Plaintiffs could not obtain an injunction blocking TripAdvisor and Liberty from executing their conversion to Nevada.²¹ Although the Court noted that “[i]n 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,” and that theoretically the Court could enjoin TripAdvisor from leaving Delaware, the equities warranting such dramatic relief were not present.²² The Court’s reasoning hinged on the availability of a monetary remedy for any harm stockholders could suffer because of the conversions.²³ One way to do so, the Court mused, “would be to value the Company pre-conversion as a Delaware corporation, then value the Company post-conversion as [a] Nevada corporation, subtract the Nevada value from the Delaware value, and calculate a per-share amount.”²⁴ Another way would be to measure the change in TripAdvisor’s trading price before and after the conversion, because “[t]he Company’s business will remain the same” and “[t]he only independent variable is the law governing its internal affairs.”²⁵ The Court concluded that it was “likely that the court will have a sufficiently reliable basis to craft a monetary award for any harm that the Company’s stockholders suffer.”²⁶

The Court of Chancery thus denied Defendants’ motion to dismiss Plaintiffs’ fiduciary duty claims and allowed the case to proceed to trial.²⁷

Despite the Court of Chancery’s Recommendation Against, the Delaware Supreme Court Grants Interlocutory Review

After the denial of their motion to dismiss, Defendants timely sought certification of an interlocutory appeal to the Delaware Supreme Court. On March 21, 2024, the Court of Chancery recommended against interlocutory review, arguing among other things that it had applied settled law and that the Supreme Court would benefit from reviewing the case on a more developed record.²⁸

On April 16, 2024, the Delaware Supreme Court exercised its “sound discretion” to grant interlocutory review.²⁹ In its succinct order, the Supreme Court noted that it would be beneficial and provide certainty to determine the appropriate standard of review for a decision to reincorporate.³⁰

Takeaways

The Delaware Supreme Court’s decision to grant interlocutory review recognizes the benefits of resolving the complex questions begged by applying a heightened standard of review to a decision to reincorporate from Delaware to another state. Interlocutory review also permits the Supreme Court to address issues not fully vetted at the trial court.

For one, the Supreme Court will need to decide which standard of review applies. In addition to considering the business judgment rule and entire fairness, the Supreme Court also could consider whether the intermediate standard of review of enhanced scrutiny applies. While no party argued, and the Court of Chancery did not address, enhanced scrutiny review, that standard permits courts to review whether fiduciaries acted reasonably in circumstances where their conduct “do[es] not rise to a level sufficient to trigger entire fairness review.”³¹ Indeed, Vice Chancellor Laster recently applied enhanced scrutiny to a controller’s defensive exercise of its voting rights to amend a company’s governing documents.³² It is possible the Supreme Court could find a reincorporation decision for a controlled company does not rise to a level warranting entire fairness review, while deciding whether the business judgment rule or enhanced scrutiny should apply.

In addition, the Supreme Court could apply existing analytical frameworks to dispose of plaintiff’s claims. For example, claims that a transaction would extinguish stockholders’ litigation rights could have been analyzed under the Court’s Primedia and Riverstone rulings, which are cited in a footnote but not discussed.³³ Under these rulings, existing litigation claims would continue, but if no claims existed, there is little reason for court intervention and the business judgment rule should protect the decision to convert to another jurisdiction.

Further, the Supreme Court could address the Court of Chancery’s hypothesized damages models. Those models themselves raise equitable considerations. For example, stockholders unsatisfied with converting from Delaware to Nevada could sell their shares before the conversion closes—capturing at least some of the value of being a Delaware corporation. On the other hand, stockholders who continue to hold in the post-conversion company arguably do not object to being incorporated in another jurisdiction. These scenarios beg the question as to which stockholders are entitled to an award. And the issue of damages becomes more pronounced if the claim is treated as a derivative claim, in which case any damages from the reincorporation would flow to the stockholders of the post-Delaware company.

To that end, the Supreme Court may consider that the challenges posed by a retroactive evaluation of damages arising from a reincorporation, and where the reincorporation does not extinguish any pending claims, warrants application of the business judgment rule to the decision to reincorporate. Such a result would provide greater certainty going forward, while allowing a claim under the Primedia and Riverstone doctrines for inequitable conduct.

Ultimately, the questions posed by Palkon I should be resolved by the Delaware Supreme Court in its eventual decision, and provide needed guidance to companies, their boards, and their advisors on the standard of review applicable to a corporate conversion from Delaware.

1. C.A. No. 2023-0449-JTL (Feb. 20, 2024) (“Palkon I”).
2. Id. at 44.
3. The following background is taken from the Court of Chancery’s decision which accepted the allegations in the complaint as true.
4. Palkon I at 8.
5. Id.
6. Id.
7. Id.
8. Id.
9. Id. at 1.
10. Id. at 11
11. Id. at 1, 19.
12. Id.
13. Id. at 14.
14. Id. at 32–33.
15. Id. at 41.
16. Id.
17. Id. at 19 n.26.
18. Id. at 20–24.
19. Id. at 33.
20. Id.
21. See id. at 47.
22. Id. at 48.
23. See id. at 50.
24. Id.
25. See id.
26. Id. at 51.
27. See id. at 52.
28. Palkon v. Maffei, C.A. No. 2023-449-JTL (Del. Ch. Mar. 21, 2024) (“Palkon II”).
29. Maffei v. Palkon, No. 125, 2024, at 5 (Del. Apr. 29, 2024).
30. Id. at 6. As the Supreme Court is likely aware, there has been a recent debate over whether certain companies should reincorporate from Delaware to other jurisdictions. See, e.g., Proposal 3, Tesla, Inc. Proxy on Schedule 14A (April 29, 2024).
31. In re Sears Hometown & Outlet Stores, Inc. S’holder Litig., Consolidated C.A. No. 2019-0798-JTL, at 66 (Del. Ch. Jan. 24, 2024). We previously wrote about the Sears decision, available here.
32. Sears, at 68.
33. See Palkon I at 19 n.26, 30 n.31; In re Riverstone Nat’l, Inc. S’holder Litig., 2016 WL 4045411 (Del. Ch. July 28, 2016); In re Primedia, Inc. S’holders Litig., 67 A.3d 455 (Del. Ch. 2013).