In October 2017, Brookfield Asset Management (Brookfield) became the controlling stockholder of Terraform Power (TerraForm). Several months later, in early 2018, Brookfield encouraged TerraForm to acquire Saeta Yield, S.A. (Saeta), a Spanish power company. TerraForm determined that it could effectuate the acquisition with US$800 million in available liquidity and a US$400 million equity offering. In connection with the equity offering, TerraForm entered into a support agreement pursuant to which Brookfield would backstop up to 100 percent of the US$400 million equity offering. Following the commencement of the tender offer, the TerraForm board opted to raise US$650 million, rather than US$400 million, and Brookfield agreed to continue to backstop 100 percent of the equity offering.
After additional discussions, in June 2018, the TerraForm board changed plans again, and decided to sell the US$650 million proposed offering directly to Brookfield in a private placement at US$10.66 per share. The private placement increased Brookfield’s holdings in TerraForm to 65.3 percent. Following the acquisition of Saeta, TerraForm’s stock price increased to US$11.77, or 10.4 percent above the private placement price.
Following the private placement, several minority shareholders brought a derivative and class action suit alleging that TerraForm and Brookfield breached their fiduciary duties by issuing stock for inadequate value, thereby diluting the financial and voting interests of the minority stockholders. After the case was filed, Brookfield acquired all of TerraForm’s remaining stock.
In its motion to dismiss, Brookfield argued that the dilution claims were exclusively derivative because all harm would flow to TerraForm, and the plaintiffs no longer had standing after the merger. The Court of Chancery denied the motion to dismiss, agreeing that the claims were exclusively derivative under Tooley, but holding that both the direct and derivative claims could still be brought because the facts of the case fit the Gentile carve-out, which held that some claims of corporate dilution are “dual-natured,” permitting both direct litigation on behalf of shareholders and derivative litigation on behalf of the company.
The Delaware Supreme Court accepted Brookfield’s interlocutory appeal to consider the Gentile carve-out to the test the Court previously established in Tooley v. Donaldson, Lufkin & Jenrette for determining whether claims are direct or derivative. Under Tooley, the determination of whether a claim is direct or derivative “must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?” In Gentile, the Delaware Supreme Court found that some claims could be both direct and derivative in nature if “(1) a stockholder having a majority or effective control causes the corporation to issue ‘excessive’ shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding shares owned by the controlling shareholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders.”
Brookfield argued that Gentile should be overturned. The Supreme Court unanimously agreed, concluding that the difficulties Delaware courts had in applying Gentile after 15 years constituted more than mere “growing pains.” The Supreme Court held that Gentile was in conflict with Tooley, leading to a carveout that was both contradictory and unnecessarily complicated. The Court also explained its decision to overturn given the weight of precedent, noting that it had ruled unanimously, and that 15 years had shown that the practical and analytical difficulties of Gentile rendered it fundamentally unworkable. The court also acknowledged that reliance on the Gentile carve-out was muted by the court’s previous decision in El Paso Corporation, in which the Delaware Supreme Court declined to “expand the universe of claims that can be asserted ‘dually’... ,” making clear that Gentile had to be read narrowly because “any other interpretation would swallow the general rule that equity dilution claims are solely derivative and cast doubt on the Tooley framework.”
Brookfield is expected to engender greater clarity and predictability in whether a stockholder’s corporate dilution claims are determined to be direct or derivative. Defendants are also now more likely to defeat merger claims at the pleading stage of litigation, especially when stockholders’ standing to bring derivative claims has been extinguished under Delaware law.